Six years ago Vice President Joe Biden said that paying taxes is patriotic. Citing the need for the wealthy to pay more of their “share” of taxes, he said it was, “time to be patriotic,” even though the top 20% of wage-earners pay 93% of federal income taxes. The latest iteration of the “paying taxes is patriotic” meme came last month when Treasury Secretary Jack Lew sent a letter to Senate Finance Committee Chairman Ron Wyden calling for a “new sense of economic patriotism.” The payment of taxes by a citizenry in a free society is not inherently patriotic, but such statements are not unexpected from those who conflate emotion with logic.
The context of Secretary Lew’s letter is important, however. Dozens of American companies have made acquisitions or merged with other companies based in the United Kingdom, or more advantageously, Ireland, in order to circumvent the U.S. confiscatory 35% corporate tax rate, which is currently the highest in the world. By basing operations in Ireland, these newly migrated companies pay a relatively paltry flat 12.5% tax on profits. Nine of the top ten global pharmaceutical companies now have operations in Ireland, and some of the largest technology companies, including Google, Twitter, and Facebook, do as well.
The process is called inversion, and here’s how it works economically. A company acquires or merges with a company in Ireland (or Britain, Switzerland, or the Netherlands) and re-domiciles there for the cash savings from U.S. tax rates. The company then lends cash back to the U.S. creating tax-deductible interest payments to benefit American operations. And in the more elaborate variation, interest costs and royalty payments made to Dutch subsidiaries reduce the tax bill in Ireland to 6%. Royalties and interest payments are then funneled to Bermuda, which then cuts the tax in Ireland to zero since Ireland views it as a “Bermuda resident.” This creates a veritable “cash mountain,” as the UK’s Financial Times refers to it, allowing the newly reorganized Irish company to pay nothing in taxes. The Financial Times estimates the “cash mountain” built up through such inversions to be as high as $1 trillion.
The absurdity of our 35% nominal corporate tax rate is magnified when we realize that the $1 trillion sitting overseas is worth a paltry $16 billion in tax revenue to the treasury, as Secretary Lew said on CNBC last month. In other words, to save $16 billion in federal corporate taxes, formerly U.S. based companies have relocated $1 trillion in cash, and all of the economic activity, including jobs and manufacturing, that a trillion dollars of cash (M1) velocity can generate. Our inordinately high tax rates have exceeded the point of diminishing return.
The reason the tax revenue can be so low as Lew’s estimate is because the average corporate effective rate is about 12% after deductions. Our tax code has become so porous through crony-capitalism that a company the size of General Electric with sales of over $120 billion, and net profit of $14 billion, could file a 57,000-page tax return for 2010 and pay no corporate income taxes. Our sieve-like tax code hemorrhages tax receipts to the U.S. Treasury.
It’s nothing short of duplicity for the administration to call for “patriotism” from entities they have been arguing are not people, and should not be afforded freedom of speech or freedom of religion rights. They have bemoaned the Citizen’s United case in which the Supreme Court ruled corporations have free speech rights, and the Hobby Lobby ruling affirming corporate freedom of religion, yet they claim such companies can have patriotism, which is an emotion and a trait that can’t be felt or manifest by inanimate objects or organizations. For logical consistency, they can’t have it both ways.
Even though Senate Majority Leader Harry Reid claimed a few years ago that paying taxes is “voluntary,” our taxes are collected from us based on principles of coercion. We pay our taxes under legal threat of fines and penalties, which could include jail time. Companies withhold a percentage of our income as a payroll deduction under threat of fines and penalties. This is also why paying taxes to “share the wealth” is not an act of magnanimity either, for coercion can never be mistaken for giving freely of our substance.
The claim that paying taxes is patriotic is prima facie specious, even if some of the benefits from paying taxes are beneficial to us personally, for tax collection is facilitated by the threat of penalty, which is coercive. As such, it much more closely resembles extortion than patriotism. In a legal context, extortion refers to how the funds are expropriated, not in how they are appropriated. Extortion is forced, while patriotism is clearly voluntary. And since patriotism is attitudinal, there’s absolutely nothing wrong with harboring such sentiments whilst paying.
Taxes are an essential component to facilitate the operations of prudent and constitutional governance. As Oliver Wendell Holmes said, “Taxes are what we pay for civilized society.” However, when tax code incentivizes the relocation of America’s engines of economic growth, its effect is deleterious to the nation. And taxation for reallocation is clearly immoral for our founders formed our system of governance to preclude the possibility of our government doing what would be illegal for an individual citizen to do.
Senate Finance Committee Chairman Senator Ron Wyden is correct to not take the band aid approach to closing the inversion loophole. His preference is to overhaul the corporate tax structure which currently incentivizes U.S. corporations to relocate headquarters and manufacturing elsewhere in the global marketplace.
The most efficacious means of repatriating that $1 trillion sitting in overseas banks would be to shred the entire corporate tax code and go to a flat corporate tax rate. That additional trillion dollars in monetary velocity could make a significant contribution to GDP expansion, as well as augmenting U.S. tax receipts.
Associated Press award winning columnist Richard Larsen is President of Larsen Financial, a brokerage and financial planning firm in Pocatello, Idaho and is a graduate of Idaho State University with degrees in Political Science and History and coursework completed toward a Master’s in Public Administration. He can be reached at [email protected].