Recently there has been quite a bit of controversy over a corporate practice of U.S. companies buying foreign corporations to reduce their taxes. This is a result of the fact that the U.S. corporate tax rate is the highest in the world among developed countries.
Mergers can be good for society when a stronger company purchases one that is poorly managed, or when economies of scale are realized in a business combination. Of course some merges are attempted to reduce competition, which is why we have antitrust laws to restrict that practice.
The recent wave of international mergers for tax purposes for the most part does not benefit society. Shareholders benefit from paying less in taxes, but our government is hurt from having less tax revenue.
The President and the Secretary of Treasury not surprisingly have been criticizing this practice because of the loss of tax revenue. Interestingly many years ago a federal judge named Learned Hand stated, “Anyone may arrange his affairs so that his taxes shall be as low as possible.” In addition Judge Hand said, “There is not even a patriotic duty to increase one’s taxes.”
In essence these corporations are arranging their affairs to minimize their taxes in a legal manner. They also have a responsibility to their shareholders to act in their best interest, which is a further justification for this practice.
There are several reasons why this practice has become more prevalent. The differential in corporate tax rates between the U.S. and foreign countries has grown, as many countries have lowered their tax rates. Financing costs are very low at the present time making mergers easier. In addition companies may be feeling less confident about the ability of Congress and the President to pass meaningful tax reform.
Despite having the highest corporate tax rates in the developed world we collect less in corporate taxes than the world average. Like our individual tax system the corporate tax system is even more so filled with loopholes, which results in companies paying widely different amounts of tax on similar incomes.
Another difference in U.S. tax law versus other countries is that our corporate tax rate applies wherever the income is earned. However, the tax from overseas profits only occurs when the money is brought back to the U.S. Because of this corporations have $2 trillion dollars parked overseas, because they don’t want to bring the money back here, and pay our high taxes.
If this money could be brought back to the U.S., that should be a positive for job creation here. Foreign sales have become increasingly important for U.S. companies, but unfortunately our tax laws have not reflected this reality.
Ideally what should happen would be for our corporate tax rates to approach the global average. We also need to factor in state taxes along with the federal tax. California has a corporate tax rate of 8.8 percent, lower than the top rate for individuals, but still higher than most states.
If there is tax reform, there will be winners and losers among companies. Some businesses benefit immensely from the present system because of deductions, and might pay more in tax even if the stated rate was lower. Those companies would lobby hard to keep their loopholes in place.
The U.S. has the most, best-run and innovative companies of any country in the world. Unfortunately our corporate tax system ranks near the bottom of the developed world in effectiveness. If we change our tax system to conform more closely to world standards, our economy will benefit.
Currently the administration wants to take action to limit overseas mergers. Reforming our present system would accomplish the same goal, rather than applying a new regulation but keeping the same system in place. Meaningful tax reform would improve our overall competitiveness and help foster job creation in the U.S.
