While for most people, thoughts of Ireland are limited to wearing green and drinking too much beer on St. Patrick’s Day, for those of us who think about tax policy, the country and its successes are worth pondering more than once a year.
Over the last three decades, Ireland has launched itself into the ranks of the wealthiest countries on the globe, and it has done so in no small part due to its enlightened tax policy. Its low tax rates on corporate profits has induced many multinationals to locate production, research and development, and other activities on the Emerald Isle. Microsoft, Google, Abbott, and Pfizer all have significant operations there, along with hundreds of other U.S. based corporations.
In recent years, several U.S. companies have gone one more step and merged with an Irish company and moved their headquarters there, in essence becoming an Irish firm. These mergers largely owe to U.S. tax law: Companies domiciled in the U.S. pay taxes in the countries where they earn their profits, and if they return those profits back to the United States they have to pay additional taxes to ensure that the effective tax rate the company pays on domestic and foreign income are the same. Virtually no other country still has such a provision and the high U.S. corporate tax rate makes that provision practically punitive.
Companies don’t like to pay that additional tax since it puts them at a competitive disadvantage when operating in a foreign country, where its competitors need only pay the local tax rate. However, U.S. companies can avoid that second layer of taxation by never returning those profits to the U.S., which is a primary reason that U.S. corporations have nearly $2.5 trillion of profits parked overseas.
But a tidier way for companies to deal with this tax rate disparity can be to simply re-domicile, which allows them to move profits to the U.S. without paying the additional taxes. A number of companies have done such a thing in the last decade and the estimated cost to the Treasury is negligible, since that money would not have returned to the U.S. if the company had to pay taxes when it returned it. Right now, Pfizer is attempting to complete a merger with Allergan, an Irish company, and Johnson Controls is doing likewise with Tyco, another company domiciled in Ireland.
While Senator Dick Durbin of Illinois and others have characterized this maneuver as unpatriotic, arguing that U.S. companies that do such a thing are avoiding paying their fair share of taxes, they invariably fail to note that these companies are paying taxes on the profits earned in the U.S., nothing changes that tax obligation. What they are doing is avoiding the counterproductive U.S. tax on foreign profits not by parking their money abroad but by moving their domicile so that the money can return to the U.S. without any tax consequence.
The solution to the current tax conundrum is simple: The U.S. should reduce its corporate tax rate—which is the highest in the OECD—and at the same time end its worldwide-cum-deferral tax regime that assesses taxes on foreign-sourced income. Doing so would immediately end the financial incentives currently in place for companies to invert while spurring domestic investment, employment and economic growth.
While reducing tax rates on businesses will be framed as corporate welfare by Senator Sanders and his ilk, the reality is that corporate taxes are borne by workers—in the form of lower wages—as well as the customers and the shareholders. The notion that corporate income taxes are merely paid by some faceless corporate entity may comport with Senator Durbin’s facile press releases but it’s a nonsensical premise that ignores basic economics.
In the last two decades the rest of the world has radically transformed its corporate tax code in a never ending quest to encourage companies to boost investment, economic activity, and hiring in their countries, and the speed with which capital can move across the globe these days has only hastened this trend. The U.S. alone has failed to change its tax code to respond to the new economic realities of the 21st century. However, the notion that companies have no choice but to operate in the U.S. is outdated and dangerous to continue to entertain. An outdated tax code makes U.S. companies less competitive and has contributed to the lower productivity gains over the last decade, which is a primary reason for the lower long-term economic growth we’ve experiences in the 21st century.
Ireland isn’t the United States: It’s a much smaller economy and it sits on the edge of the European Union and its plethora of trading partners who enjoy duty-free access to its markets. However, we can still take a page from Ireland’s robust growth and begin debating a wholesale reform of our tax code that makes it easier for U.S. businesses to invest, grow and compete both here and throughout the world.
Ike Brannon is the president of Capital Policy Analytics, a Washington, D.C., consulting firm.
