Tax Inversion-What It Is Really About
When Did the U.S. Forfeit its Moral Leadership in the World?

Are Corporate Inversions a Violation of Ethics?

What is the "Fair Share" concept and "Social Responsibility" of Corporate Income Tax Payments to the U.S. Government?

I recently blogged about tax inversion with respect to Walgreens possible relocation to Europe as a way to reduce its corporate tax burden. Three hedge funds and a Goldman Sachs investment fund want Walgreens to consider a tax “inversion” and move to Europe. Walgreen Chief Executive Greg Wasson and the company’s chief financial officer recently met in Paris with a hedge fund group that wants the company to leave Illinois for what would most likely be Switzerland, which has lower tax rates.

On July 18 the U.S. drug maker AbbVie announced a plan to buy U.K.-based Shire in a $54 billion deal, from which AbbVie will emerge as a subsidiary of the U.K. firm. It is but the latest example in a flurry of acquisitions known as inversions.

In an inversion, a large U.S. firm acquires a much smaller target company domiciled in a tax-friendly jurisdiction such as Ireland, Switzerland or the U.K., but the deal is structured so that the foreign minnow swallows the domestic whale. U.S. shareholders of the U.S. firm must pay immediate capital gains tax for the privilege of inversion, and the U.S. Company ends up as the nominal subsidiary of a publicly held foreign corporation.

The deals are driven by a desire to avoid paying U.S. corporate income taxes that are the highest in the world (35%) by relocating to a tax-friendly country. The UK tax rate is 21%, Switzerland is 18% and Ireland, with the lowest corporate income rate, at 12.5%. U.S. companies avoid paying any corporate income taxes by shifting profits overseas so that taxes are avoided until and unless those profits are repatriated from their low-taxed foreign earnings to the U.S. By simply keeping the profits overseas a U.S. company avoids paying U.S. corporate income taxes.

Inversions threaten to reduce the amount of corporate income tax paid into the U.S. treasury at a time when taxable income is rising as the economy recovers. The U.S. expects to take in $332.7 billion in corporate income tax this year, more than 20% above the $273.5 billion it collected last year. That figure could rise as high as $528 billion by the end of 2017, according to White House projections. But as more companies leave U.S. shores for lower tax havens, that figure could shrink. Inversions could cost the U.S. government about $19.5 billion in lost tax revenue over the next decade, according to recent projections from the bipartisan Joint Committee on Taxation.

Research firm Audit Analytics indicate that corporate earnings was up 93 percent from 2008 to 2013, citing federal financial filings for companies listed in the Russell 1000 index of U.S. corporations. Conglomerate General Electric had the biggest pile of earnings stored abroad, at $110 billion. Next were software maker Microsoft, with $76.4 billion; drug makers Pfizer with $69 billion and Merck with $57.1 billion; and high-tech group Apple with $54.4 billion.

Inversions are "legal" in the sense that they do not violate relevant tax rules. But the real question is whether inversion policies are ethical. Compliance with laws and regulations is a minimal standard of ethical behavior. Ethics requires that we look at the consequences of our actions and decide what the most ethical course to take is.

The morality of tax inversion policies is linked to the criteria used to make such determinations. For example, from a shareholder point of view the company should maximize profits to enhance shareholder wealth and provide for the highest amount of dividend payments. This is more likely to occur when tax inversion policies are followed. However, an argument can be made that tax inversion policies shield U.S. corporations from paying their “fair share” of taxes.

If corporations pay the higher U.S. corporate tax rate are they acting in a ‘socially responsible’ manner? Our capitalist economic system relies on the belief that corporate managers should act in the best interests of shareholders. And, as noted economist Milton Friedman stated in a 1970 essay in the NY Times Magazine, the only social responsibility of business is to maximize profits to enhance shareholder wealth. Friedman believed the basic doctrine of "social responsibility" involves the acceptance of the socialist view that political mechanisms, not market mechanisms, are the appropriate way to determine the allocation of scarce re­sources to alternative uses.

I believe the issue of social responsibility is a relevant moral consideration in examining tax inversion policies. Friedman’s point of view notwithstanding, just imagine if all corporations acted to shield corporate income and pay lower or no taxes to the U.S. government.

My suggestion is to institute a lower rate of 15% to be competitive with other industrialized countries, and keep it in place for two years. If this leads to repatriated profits, higher taxes paid to the government, and the in-sourcing of jobs, then the 15% rate should be made permanent. If, however, U.S. businesses continue to shift their profits overseas and continue to outsource jobs, it means one or more of three things: (1) they are motivated by lower wage rates outside the U.S.; (2) they may feel stifled by the excessive regulatory system in the U.S.; and (3) they may truly want to be closer to their expanding overseas markets.

Corporate America reacts to incentives to maximize profits that can lead to higher personal income through bonus and other incentive compensation, and rising stock prices. There is nothing wrong with it. It is a part of our system. However, we must begin to initiate policies to reduce the growing number of people in poverty, bring more into the middle class, and do what is necessary to reverse years of stagnant growth that has resulted in steady or reduced earnings of all to many currently in the middle class. In my view this is an ethical issue, not one based on paying a fair share of the taxes. Corporations have an ethical obligation and social responsibility to do what it takes to improve the economic circumstances of all members of its community -- a community that depends on jobs and economic activity. Our society cannot prosper without an ever-expanding middle class and lowering of the poverty rate in this country.  

Blog posted by Steven Mintz, aka Ethics Sage, on July 29, 2014. Dr. Mintz is a professor in the Orfalea College of Business at Cal Poly, San Luis Obispo. He also blogs at: www.workplaceethicsadvice.com.

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