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.

IRS Chief: Taxpayers To Begin Feeling Sequester Pinch

Cuts Are Hurting The Entire US Recovery; Not Just the IRS
Cuts Are Hurting The Entire US Recovery; Not Just the IRS

Acting IRS Commissioner Steven Miller stated recently, that taxpayers will soon start feeling the effects of the Sequester now that the tax season has ended.  Deep cuts to IRS Staffing will impact taxpayers calling the IRS, as well as the agency’s ability to combat fraud and collect tax revenues.

Treasury secretary Jacob Lew also chimed in by saying that for every $1 dollar spent on IRS collection activities, $6 dollars are generated.  Therefore, cutting back on the ability for the IRS to collect revenues would be short-sighted to say the least.  Miller Said:

“Without a change in the current budget environment, the American people will see erosion in our ability to serve them, and the federal government will see fewer receipts from our enforcement efforts…”

Mandatory furloughs for IRS works have already been put into effect as well.  While there was early hope that Republicans & Democrats would come together to avoid what many are describing as “self-inflicted” wounds, that prospect has dimmed significantly since we fell off the “fiscal cliff”.  Democrats are adamant about including revenues and spending on projects such as infrastructure & early education, while Republicans are standing firm about extracting just cuts.  Unfortunately for the G.O.P., this “cuts only” policy is starting to show it’s negative effects on our fragile recovery.  With the extreme austerity measures being taken in the E.U., the evidence has shown that it has hampered–not improved–growth.  

After two years in which President Obama and Republicans in Congress have fought to a draw over their clashing approaches to job creation and budget deficits, the consensus about the result is clear: Immediate deficit reduction is a drag on full economic recovery.

According to economists, the unemployment rate would be 1 point lower (6.5%) and U.S. economic growth would be almost 2 point higher, had congress not cut spending and did not let the payroll tax cuts for Social Security expire.