Rather than begrudge Burger King or Apple for its rational business decisions, policymakers should repair the incentives that drive capital away from the United States.

Cato Institute
Cato at Liberty

By: Daniel J. Ikenson
Date: 25 August 2014

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When a Hamburger Becomes a Doughnut and Other Lessons About Tax Inversions and Globalization

 

So Burger King plans to purchase Canadian doughnut icon Tim Hortons and move company headquarters north of the border, where corporate tax rates are as much as 15 percentage points lower than in the United States.  Expect politicians at both ends of Pennsylvania Avenue to accuse Burger King of treachery, while spewing campaign-season pledges to penalize these greedy, “Benedict Arnold” companies.

 

If the acquisition comes to fruition and ultimately involves a corporate “inversion,” consider it not a problem, but a symptom of a problem. The real problem is that U.S. policymakers inadequately grasp that we live in a globalized economy, where capital is mobile and products and services can be produced and delivered almost anywhere in the world, and where value is created by efficiently combining inputs and processes from multiple countries.  Globalization means that public policies are on trial and that policymakers have to get off their duffs and compete with most every other country in the world to attract investment, which flows to the jurisdictions where it is most productive and, crucially, most welcome to be put to productive use.

 

Too many policymakers still believe that since the United States is the world’s largest market, U.S.-headquartered companies are tethered to the U.S. economy and committed to investing, hiring, and producing in the United States, regardless of the quality of the business and policy environments. They fail to appreciate how quickly the demographics are changing or that a growing number of currently U.S.-based companies do not share their view. Perhaps too many are unaware of how the United States continues to slide in the various global rankings of attributes that attract business and investment. The leverage politicians have over America’s corporate wealth creators has diminished.

 

Like most U.S.-based multinational corporations that face tax rates of 35 percent on profits repatriated from abroad, Apple devotes resources to navigating the maze of rules to minimize its tax burdens. Last year, Senators Carl Levin (D-MI) and John McCain (R-AZ) ripped into Apple CEO Tim Cook for his company’s efforts to reduce its taxes. Levin said: 

Apple sought the Holy Grail of tax avoidance. It has created offshore entities holding tens of billions of dollars, while claiming to be tax resident nowhere. We intend to highlight that gimmick and other Apple offshore tax avoidance tactics so that American working families who pay their share of taxes understand how offshore tax loopholes raise their tax burden, add to the federal deficit and ought to be closed.

Unlike foreign-based multinationals whose governments don’t tax their profits earned abroad (or do so very lightly), U.S. multinationals are subject to double taxation—first at local tax rates in the foreign countries where they operate and then by the IRS, at up to 35 percent, when profits are brought home. Is it a surprise that such a system discourages profit repatriation? Who’s to blame for depriving the U.S. economy of working capital and encouraging elaborate – but legal – tax avoidance schemes?

 

Sen. McCain at least acknowledges the faults and disincentives of the system, but then blames Apple for pursuing the interests of its shareholders anyway:

I have long advocated for modernizing our broken and uncompetitive tax code, but that cannot and must not be an excuse for turning a blind eye to the highly questionable tax strategies that corporations like Apple use to avoid paying taxes in America. The proper place for the bulk of Apple’s creative energy ought to go into its innovative products and services, not in its tax department.

Senators Levin, McCain, and others who prefer to strong-arm U.S. wealth creators should consider carrots instead of sticks. The United States is competing with the rest of the world to attract investment in domestic value-added activities. Companies looking to build or buy production facilities, research centers, biotechnology laboratories, hotels, or burger and doughnut joints consider a multitude of factors, including size of the market, access to appropriately skilled workers and essential material inputs, ease of customs procedures, the reliability of transportation infrastructure, legal and business transparency, and the burdens of regulatory compliance and taxes, to name a few. The capacity of the United States to continue to be a magnet for both foreign and domestic investment is largely a function of its advantages with respect to these considerations. As I noted in a paper on this subject last year:

Unlike ever before, the world’s producers have a wealth of options when it comes to where and how they organize product development, production, assembly, distribution, and other functions on the continuum from product conception to consumption. As businesses look to the most productive combinations of labor and capital, to the most efficient production processes, and to the best ways of getting products and services to market, perceptions about the business environment can be determinative. In a global economy, “offshoring” is an inevitable consequence of competition. And policy improvement should be the broad, beneficial result.

Combine the current tax incentive structure with stifling and redundant environmental, financial, and health and safety regulations, an out-of-control tort system that often starts with a presumption of corporate malfeasance, exploding health care costs, and costly worker’s compensation rules,  the reasons more and more businesses would consider moving operations abroad permanently become obvious. Thanks to the progressive trends of globalization, liberalization, transportation, and communication, societies’ producers are no longer quite as captive to confiscatory or otherwise suffocating domestic policies. They have choices.

 

Of course, many choose to stay, and for good reason. We are fortunate to still have the institutions, the rule of law, deep and diversified capital markets, excellent research universities, a highly skilled workforce, cultural diversity, and a society that not only tolerates but encourages dissent, and the world’s largest consumer market. Success is more likely to be achieved in an environment with those advantages. They are the ingredients of our ingenuity, our innovativeness, our willingness to take risks as entrepreneurs, and our economic success.

 

But those advantages are eroding. According to several reputable business-perception indices, the United States has slipped considerably over the past decade in a variety of areas that directly impact investment decisions. (See “What Really Drives the Investment Decision” begininng on page 15.) Out of 142 countries assessed in the World Economic Forum’s Global Competitiveness Index, the United States ranks 24th on the quality of total infrastructure; 50th on perceptions that crony capitalism is a problem; 58th on the burden of government regulations; 58th on customs procedures; and 63rd on the extent and effect of taxation. Meanwhile, uncertainty over energy, immigration, trade, tax, and regulatory policies continues to deter investment and even encourages companies to offshore operations that might otherwise be performed in the United States.

 

Rather than begrudge Burger King or Apple or any other profit-maximizing company for its rational business decisions, policymakers should repair the incentives that drive capital away from the United States.