Tax inversions, private sector job growth, debt-to-equity ratios of largest U.S. firms and record earnings: what do they have in common?
The preponderance with which all have seeped into public discourse has come without the consideration that each situation may offer an opportunity to manage the future growth rate of U.S. federal debt.
Let’s focus, for now, on the issue of corporate tax inversion.
A situation of tax inversion occurs when a domestic firm becomes headquartered abroad to benefit from more favorable corporate income tax policies. One way for a firm to accomplish this is to acquire a foreign firm at least 25 percent its size.
Of course, the resources necessary to embark on a major shift in firm “location” imply that larger firms’ balance sheets may benefit disproportionately relative to small businesses which, in reality, harness much of the job creation in the U.S.
Since 1982, roughly 43 American companies have inverted, 13 since 2012 and nine more are pending for 2014 – Burger King’s purchase of Canadian-based firm Tim Horton’s is just the most recent example.
One-third of inversions since 2005 have centered on Ireland whose corporate tax rate of 12.5 percent is lower than the 35 percent rate levied by the U.S., which excludes state tax rates. Still, countries such as Bermuda and the Caymans, who boast a corporate friendly zero percent tax rate, are unlikely to alter policy in the near future. The weighted average tax rate for the most developed countries in the OECD is 29 percent.
The budget status of the U.S. is a convoluted creature. On the one hand, the 2013 deficit has
been reduced by a staggering 37 percent from 2012, reductions in public sector employment notwithstanding.
On the other hand, while the current public debt-to-GDP ratio of 72.5 percent is not in the red zone, the growth rate over the last six years is unsustainable. However, federal expenditures and tax revenue are two sides of the same fiscal coin, and S&P 500 firms are healthier now than in recent decades.
The largest American firms are sitting on trillions of dollars in marketable debt securities and cash while experiencing record high earnings per share and record low net-debt to earnings ratios.
The U.S. Treasury Department estimates $17 billion to $19 billion would be salvaged over the next 10 years from eliminating tax inversions. When evaluating tax policy, however, the average effective tax rate, which accounts for tax loopholes and deductions, is the tax rate that really matters.
Last year, Apple’s CEO Tim Cook, in congressional testimony, revealed that the firm evaded $74 billion in taxes from 2009 to 2012 through elaborate schemes of international subsidiaries and loopholes. A follow-up report conducted by the Government Accountability Office in 2013 found that the average effective corporate income tax rate for the most profitable U.S. firms was 12.6 percent in 2010 (16.6 percent when foreign, state and local taxes are included).
These results rank the U.S. in eleventh place for lowest average effective corporate tax rate among 27 of the wealthiest nations.
Naturally, when confronted with the statistics that measure actual cash flow, advocates for slashing corporate tax rates cite a systematically flawed tax code calling for a complete overhaul to the laws.
It’s true. Tax reform may be the hot-button issue going into mid-term elections.
The U.S. may want to consider the way territorial profits are treated. As it stands, the United States is one of the few advanced countries to treat foreign and domestic profits under the same tax umbrella – most nations do not apply the domestic tax rate (if any nonzero rate) to profits earned abroad.
One option for the U.S. might involve a revenue-based corporate tax policy in an attempt to dissuade poverty-chasing firms from seeking low wage labor abroad. Of course, this and other topics related to tax code reform warrant objective analysis prior to taking center-stage in November.
Nicholas J. Mangee is an assistant professor of economics at Armstrong State University and can be reached at Nicholas.mangee@armstrong.edu.