Corporate inversions – when American companies reincorporate abroad to lower their tax bills – have become a political controversy solely because of the screwiness of the U.S. tax system. If our government taxed companies based on their consumption, or on the income they make on U.S. territory, or on where their shareholders live, then the place where they were chartered would have no tax consequences.
Our government has instead decided to tax the worldwide profits of companies chartered in the United States, and is then shocked that companies prefer to move their charters elsewhere.
The Obama administration is taking regulatory action to deter companies from avoiding U.S. taxes this way, and urging legislative action as well. Republicans think that instead of new regulations we should move toward a territorial tax system where charters don’t matter so much and then cut corporate tax rates. Many Democrats, too, have called for lower corporate rates, including President Barack Obama himself.
Compared to other developed countries, which have been cutting their rates over the last few decades, the U.S. has high corporate taxes (even after accounting for loopholes). Lower rates should bring more investment here, and that should in turn raise wages.
Yet neither a strong case nor bipartisan support has been enough to overcome several obstacles to rate reduction. Cutting corporate rates will probably lower federal revenue. If policymakers try to make up for the revenue loss by, for example, slowing down the rate at which companies can write off their investments, then they will defeat the point of the exercise: New investments in the U.S. would become less attractive rather than more so.
Many businesses pay taxes under the individual income tax. Their taxes went up last year, so the trade associations that represent them in Washington will complain if corporations get a cut. But reforming the individual tax code as well as the corporate one would vastly complicate the legislative task.
The way to cut this political knot, I think, starts with moving to territorial taxation, as the Republicans urge. But the second step shouldn’t be to lower the tax rate on corporate income. Instead, it should be to lower taxes on business investment.
Companies – whether they pay the corporate or individual rate – should be allowed to deduct the full cost of their investments in the year they make them, instead of stretching out those deductions for years.
Republican Rep. Devin Nunes has been working on a reform along these lines. So have Republican Sens. Mike Lee and Marco Rubio. The result of this reform would be a simpler business tax system and more investment in the U.S.
There would be fewer inversions, too – and fewer reasons to care about them.