How should we stop corporations from leaving the
United States, as both presidential candidates have vowed to do? After Pfizer announced this year
that it wanted to merge with the Ireland-based Allergan in a maneuver known as
a corporate inversion, the Obama administration put in new tax rules that effectively
scuttled the deal.
President Obama characterized inversions as a way
American companies to “get out of paying
their fair share of taxes here at home.” Last month, the Chamber of Commerce sued to block the new
rules, saying that the
administration “simply rewrote the law unilaterally.”
We need to put aside the politicized allegations that
inversions are a way for corporations to cheat the rest of America. This sort
of language confuses the issue and obscures a central fact: All of these
corporations are owned by shareholders who should, in theory, reap the benefits
of a lower corporate tax bill.
Unfortunately, in our zeal to keep companies in the
United States, we have created policies where inversions benefit some
shareholders at the expense of others. Perversely, the inversion rules are more
likely to punish American investors and long-term investors to the benefit of
senior executives, recent investors and tax-exempt investors, including those
overseas.
In a recent paper, we look at 60 inversions by United States public companies
dating back two decades, to when policy makers started to discourage companies
from leaving the United States by requiring stockholders to pay capital gains
taxes on their shares at the time of an inversion.
Overall, taxable
shareholders lost 1 percent to 3 percent on the value of their shares. This may
sound small, but it amounts to around $6 billion in extra taxes for the
shareholders. So while inversions reduce the corporate taxes collected by the
Treasury, the extra taxes paid by shareholders offset that loss by about 40
percent.
Fifteen percent to 20 percent of shareholders in the
deals we studied were made worse off from inversion. The anti-inversions tax
rules are especially bad for long-term investors who have higher capital gains
because they have seen their shares appreciate significantly over the years.
For example, investors who bought Pfizer five years ago have had their shares
appreciate by 80 percent; investors who bought 25 years ago have seen their
shares grow by six times (adjusted for splits).
For older Americans who plan to bequeath shares to
spouses or heirs, an inversion is especially costly. These individuals end up
paying capital gains taxes upon inversion that they would otherwise avoid
through a bequest.
In effect, one group of shareholders writes a large
check to the government for all shareholders to reap the benefits of lower
corporate income taxes in the future. For some shareholders, an inversion can
be quite expensive. Former directors of Medtronic voiced their opposition to an
inversion that engendered a substantial tax
liability for longtime shareholders.
(The tax cost of an inversion also explains why
companies with founders who hold large ownership stakes, like Facebook, would
never consider inverting: such a maneuver would require Mark Zuckerberg to cut
a $14 billion check to the government to cover the capital gains tax on his shares.)
But tax-exempt investors enjoy a nice return from
inversion of 4 percent to 7 percent. These include investors in millions of
retirement accounts, pensions and endowments across the country, who do not pay
taxes when an inversion occurs. Even tax-deferred investors, such as most
401(k) and traditional I.R.A. accounts, are exempt from capital gains taxes.
Foreign shareholders also benefit, as
the I.R.S.’s special tax rules don’t apply in other countries.
There’s a third group that benefits: corporate
executives. We found that the chief executive’s wealth increases 3 percent to 4
percent, despite the personal tax consequences of inversion. This is in part
because stock options, unlike shares, are not subject to capital gains tax at
inversion. In 2004 the government added a tax on pay for executives of
inverting companies but the companies began reimbursing their executives for
this expense, passing the cost along to shareholders.
There are several steps
the United States can take to discourage inversions. A lower corporate tax rate
and the removal of taxes on foreign earnings would certainly reduce the
incentives for companies to leave. If we coupled a lower corporate rate with a
reduction in the deductions companies now have, we could maintain the current
level of tax revenue while at the same time simplifying the tax code and
remaining competitive.
First, though, we should abandon the policies that
have punished long-term and older taxable American shareholders, while other
investors — foreign, tax-exempt and corporate insiders — benefit. And the rules
have failed in their primary mission of discouraging corporate inversions:
Companies worth over half a trillion dollars announced their intention to
invert since 2014. In short, we have the worst of policy effects: unintended
consequences and no intended ones.
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