U.S. Companies NOT Fleeing High Tax Rate... Oh, Really?

Feb 11, 2015

A recent (2/9/15) Reuters article suggests that the accelerating trend of large U.S. companies reincorporating abroad, sometimes called “tax inversions,” is NOT motivated by the statutory U.S. federal tax rate, at 35% one of the highest corporate rates in the world. An interesting perspective, but the numbers they cite don’t support it. Yet again, this is an instance that illustrates the importance of being careful about the words that we wrap around the numbers.

The story’s central point is that while the U.S.’s statutory federal tax rate is 35%, the effective tax rate – that is, a company’s actual total tax provision, calculated as a percentage of its net income – for the sample of companies doing tax inversions was around 20% (give or take, depending on analysis methodology). Not only is that lower than the U.S. statutory rate, it’s lower than the statutory rates in some of the countries to which these companies are moving. Ergo, the article suggests, the 35% tax rate is not the cause of these inversions. Though I am by no means a corporate tax expert, I still say, “BALONEY!”

First of all, the story ignores the possibility that effective rates differ from statutory rates in other countries just as they do in the U.S. Perhaps the complexity and loopholes in the U.S. system cause a larger disparity between the two rates than there is in other countries, but significant disparities may still exist, making tax inversions still a good deal. The Reuters story is completely silent on that point.

Second, the marginal tax rate – that is, the rate a company will pay on incremental income – could be significantly higher than the effective rates quoted, and perhaps even close to the statutory rate. So U.S. companies might choose to domicile elsewhere, not only because of the current taxes they’re paying, but because of the additional taxes that will owe as they grow. Again, the Reuters story is silent on this matter.

Lastly, if you’re going to reject the most widely-held hypothesis for why there are tax inversions, the least you could do is provide other reasons why these companies might be taking an action that is expensive, complex, and obviously not good for a company’s P/R. But the Reuters story offers no alternative explanations.

When huge U.S. corporations move overseas, that’s a serious issue that deserves serious analysis, and not half-baked arithmetic.

“Painting with Numbers” is my effort to get people to focus on making numbers understandable. I welcome your feedback and your favorite examples. Follow me on twitter at @RandallBolten.