Inversions and the worldwide minimal tax

In the early 2010s, there appeared to be a parade of big companies announcing their intention to escape a US tax law that had gotten significantly out of hand with the rest of the world. These cross-border mergers were an evolution of a long-standing phenomenon known as “expatriation” or “inversion”. In fact, politicians were well aware of this development. There were a number of corporate inversions in the 1990s and early 2000s in which US firms relocated overseas to reduce their tax burden. This phenomenon has been the subject of hearings in Congress, and in 2004 Congress passed a law to limit tax benefits from inversion transactions.

This policy has somewhat curbed “bare” inversions, where companies simply reorganized into a lower-tax jurisdiction but otherwise did not change ownership or business activity. But the reform did not significantly reduce the relative disadvantage imposed on US-headquartered companies. The result was that cross-border mergers and acquisitions replaced bare reversals as a means of achieving corporate expulsions and have continued for the past decade.

Previous governments tried and failed to regulate this corporate flight to stop them. While there is some evidence that regulation has reduced some of these incentives, the yawning gap between the US tax system and that of other major trading partners was simply too wide to fully address the issue. The Tax Cuts and Jobs Act (TCJA) did just that in 2017, cutting the U.S. corporate rate to a more competitive rate. Today the United States has a combined rate of 25.75 percent, which is the twelfth highest in the Organization for Economic Co-operation and Development (OECD) and slightly above the 22.85 percent average among the 37 OECD countries. The TCJA also shifted the tax treatment of foreign-sourced income to a territorial system consistent with the overwhelming majority of large US partners.

The evidence of the success of this policy change is perhaps best understood through what we fail to see: corporate inversions. In fact, a company that had announced its intention to merge with a foreign partner restructured the deal to remain in the United States after the TCJA went into effect.

But the Biden administration has proposed moving the tax law back to the 1990s by raising the corporate tax rate to 28 percent and returning to an outdated style of taxing foreign income. The rate hike would restore the United States to its former status as the highest corporate income tax among the major world economies. Recall that the impartial Joint Tax Committee determined that the TCJA would lead to greater investment in the United States. The Biden administration’s tax policy would reverse these incentives and make the United States less attractive to investment.

None of this is particularly new – in fact, successive administrations ran a broken tax regime that caused large corporations to relocate abroad. It was just the cost of a tax number that no one could fix. But the big push by the Biden administration to convince the rest of the world to introduce a minimum corporate tax is a new development. It is also a tacit recognition of the risks the corporate tax proposals otherwise pose to US companies. The effect of the minimum tax is to narrow the gap between high-tax and low-tax countries, which encourages where companies invest.

The outlook for the tax plans of the Biden administration and the agreement on a global minimum tax remains unclear. What is clear is that some policy makers have learned the lesson that inversions lead to bad economies and bad press. Unfortunately, they still don’t know how to avoid them.