How a Tax Loophole Allows Corporations to ‘Invert’

Corporate Inversions Are Increasing Drastically
Corporate Inversions Are Increasing Drastically

Imagine, as an American, choosing to become a teacher in Russia, or a tour guide in Italy. According to U.S. tax law, you would have to pay taxes on your earnings, just as you would if you worked domestically. Now, imagine you’re an American corporation which has just purchased a foreign company. You shift over ownership and operations to your new foreign holdings and become subject to a different set of tax laws, allowing your business to avoid paying what it otherwise would in taxes.

In fact, the money wouldn’t even be treated as American money. The process described above is known as inversion, and will be used by American corporations to shift their ownership overseas and dump profits into tax shelters around the world to the tune of $20 billion over the next ten years. Congress is aware of it as an issue, but a successful approach to stemming capital flight remains elusive.

Are Inversions Helping the Economy… or Corporations?

While the Obama administration made fixing these loopholes a priority earlier this year, most on all sides agree these are temporary measures unlikely to stop any real, long-term capital flight. The main reason for this is because while such capital expatriation schemes work in the short-term, other loopholes exist to shift ownership. As a result, there are two solutions that are seriously being discussed: one on the side of the multinational corporations themselves, and another which is now starting to gain traction in economic circles and which was the subject of recent lectures at NYU.

Changing the Tax Structure to Inhibit Capital Flight

Most multinationals and think-tanks that want change would prefer change that would continue to allow corporations to do multinational business. The general basis of this argument runs as follows: if the taxation scheme in the U.S. were friendlier to businesses, this would stem capital flight and cause corporations to reinvest in the U.S. The motivation would stem primarily from tax incentives to do business in the U.S., thus reducing the costs of operation for corporations who would otherwise turn overseas.

Not all investors agree that a “trickle-down” solution would actually work. Controversial venture capitalist Nick Hanauer points out that companies given indirect incentive to reduce their costs at a domestic level often fail to reinvest in their domestic workforce, but in fact simply add that money into their general profits. It is difficult to see how continuing to provide incentive to reduce corporate costs internationally would change that paradigm. Since such a program would in no way incentivize such corporations to shift their profits back into U.S.-based research and development, this answer seems to simply reward corporations already using a tiered structure.

Internationalizing Capital Taxation

An alternate solution being proposed, however, would more directly impact how inverted companies do business: by requiring a consistent standard on global profits as opposed to simply reported American profits. This would immediately force companies profiting in the U.S. but diverting their profits outside the country to still pay taxes on them. This would ensure that companies making money in the United States would have to pay their fair share, regardless of where they try to move their money.