Treasury Secretary Calls for Reform to Keep Corporations from Fleeing Taxes

Rich people and corporations who keep money in foreign tax havens cost states $39.8 billion in 2011. Jack Lew says its time to stop them.
by | September 8, 2014

U.S. Treasury Secretary Jack Lew called on Congress Monday to pass so-called “anti-inversion” legislation to make it harder for U.S. companies to merge with foreign ones in order to avoid paying U.S. taxes.

In a speech to a Washington, D.C., policy institute, Lew urged that any federal tax reform “create an environment where business decisions are made for business reasons, not for tax purposes.” He cited an “increasing number” of corporate mergers in recent years where U.S. companies end up changing their place of residence to a foreign country.

“This practice allows corporations to avoid their civic responsibilities while continuing to benefit from everything that makes America the best place in the world to do business,” Lew said at an Urban Institute event. “This may be legal but it’s wrong -- and the laws should change.”

Lew asked for a bipartisan effort to pass a proposal by President Obama that would ban a company from claiming foreign tax residence if it is still managed and controlled in the United States, does a significant amount of its business here and does not do a significant amount of its business in the country it claims as its new home. Such legislation, he added, should work retroactively, applying to any deal after early May of this year to avoid a rush of companies trying to close pending deals. He also pushed for overall tax reform, noting that Obama's proposal includes simplifying the corporate code to close loopholes and would establishing a top rate of 28 percent. The current rate is 35 percent.

An “inversion” is when a U.S. company merges with a foreign company, allowing it to relocate headquarters overseas and thus substantially lower its tax bill. The U.S. not only has the highest corporate tax rate in the developed world, it also enforces a worldwide method of taxing its headquartered companies, meaning it taxes income earned overseas. Most other countries employ a territorial method, meaning that only income earned in that country is taxed.

State corporate income taxes for businesses earning more than $100,000 range from 4.53 percent in North Dakota to 10 percent in Iowa (which also has a 12 percent tax bracket for higher earners). Three states (South Dakota, Wyoming and Nevada) don’t tax corporate earnings. Last year, a U.S. PIRG study found that states lost approximately $39.8 billion in 2011 tax revenues from corporations and wealthy individuals sheltering money in foreign tax havens. (Multinational corporations accounted for more than $26 billion of the lost revenue.) California, New York, Illinois, New Jersey and Pennsylvania were the top five states that lost the most in corporate tax revenue.

Recently, the United Kingdom transitioned to a territorial corporate tax system and in 2015 will lower its tax rate to 20 percent (from 23 percent). “That government wants to send out the signal loud and clear that Britain is open for business,” said General Electric Company’s tax attorney John Samuels in a panel following Lew’s speech. “They are saying, ‘We want our tax system to be considered an asset not a liability in retaining U.K. companies.’”

The strategy has yielded quick results. After merging earlier this year, Fiat Chrysler Automobiles announced in August that the headquarters for the Italian-U.S. automaker would be in Britain. A Fiat spokesman cited the company’s need to establish tax residency in the U.K. as a primary reason for the relocation. The inversion isn’t the first for Chrysler, which is headquartered in Michigan -- in 1998, the company merged with German automaker Daimler-Benz in a $36 billion deal that included shifting residency to Germany. (The two companies parted ways in 2007 when Chrysler was bought by U.S.-based Cerberus Capital Management.) A Chrysler tax attorney had told Congress a year before the merger that the U.S. tax system put it “at a major disadvantage and became a major concern” when it came time to choose residency.

As other countries seek to make their tax codes friendlier, inversion has increased. So far this year, 14 U.S. companies have announced plans to merge with foreign companies or relocate overseas. In the 1980s, Samuels noted, 23 percent of U.S. firms’ profits were earned outside of the U.S. “Today,” he said, “more than half are.”

In addition to Obama's, several other tax reform proposals that would cut tax preferences and lower the corporate rate have been introduced on Capitol Hill. Serious attention to tax reform is a long way off, however. Part of the barrier to corporate tax reform is the perception that companies are already finding loopholes in the tax code and not paying their fair share. But, argues President of the Committee for a Responsible Budget Maya MacGuineas, in the global marketplace, the U.S. has to think about how and what it taxes. “The reality is that corporate taxes are passed on to customers, employees and shareholders,” she wrote in an August commentary in the Wall Street Journal that promoted shifting the corporate tax to wealthy individuals. “And as borders become more porous and corporate structures and capital become more mobile, corporate taxes increasingly encourage inefficient and costly behavior.”