Corporate Tax Avoidance and Inversions

After a discussion about corporate tax avoidance, I made an interesting discovery that equating corporate inversions with moving profits overseas to avoid tax burdens is a common misconception.  In case anyone was wondering, that’s clearly untrue. Inversions are a uniquely American phenomenon since the US is the only developed country to force its home-based corporations to pay not only taxes in a foreign country, but also American taxes on profits earned abroad.  This is one of the more bizarre elements of the tax code and also results in Americans living overseas being forced to renounce their citizenship to avoid back taxes. Moreover, the State Department has tried to make it far more difficult to renounce your citizenship in order to keep people paying taxes.  Yes really.

Anyways, inversions are the corporate version of renouncing your American citizenship; by becoming a foreign entity, American companies do not have to pay taxes on income they earned overseas. Of course, income in the United States is still taxed exactly the same. I would think this would be obvious, since foreign companies still have to pay US income tax on US profits, but hey, tax law is complicated.

Are there ways to not just avoid paying taxes on foreign income, but actually move profits around? Yes! One of the more famous such methods is called the “Double Irish Arrangement”.  The basic gist is that Ireland not only has a low corporate tax rate, but also allows a company to be incorporated in Ireland while not being a “tax resident” of Ireland.  This first company (the non-tax resident) is based in a tax haven such as the Cayman Islands or Bermuda and licenses intellectual property or some other asset to a second company (also based in Ireland).  This second Irish company is a tax resident of Ireland, but its profits are greatly reduced since it pays high license fees to the first company.  Profit flows into the second company but is immediately siphoned off to the first company, avoiding most taxes.  The second company owes nothing in taxes at all. Of course, it appears Ireland is ending the practice of allowing companies to incorporate in Ireland while not being a tax resident.

But there is a real question that should be asked as to whether the US should have a high corporate tax rate, or even have any corporate income taxes.  If corporate profit were not taxed, it would flow to a variety of possible destinations: lower prices for consumers, increased business for suppliers, higher wages for employees (or more employees), or to stockholders in higher returns.  Stockholder returns and wages are of course already taxed, and consumer price reductions and increased supplier business are benefits to economic growth.  But setting aside economics, if taxing corporations is an effort to redistribute wealth, it’s a pretty roundabout and silly way of doing it; it reduces economic growth while catching millions of people’s retirement returns along with it.

Is setting the corporate income tax to zero crazy? Perhaps. But the current corporate tax structure is already insane, and is itself the source of many crazy legal constructs.  Moreover, the current system makes the the arguments for a zero percent rate sound like an excellent alternative.  Thus, it’s pretty clear that reforming the current corporate tax system to at least be a lower rate and less complex, as well as ceasing the practice of double taxing companies for foreign income is a no-brainer.