When
I was very young (President Kennedy young) my family lived in
Germany. While living there we had a man visit from Rhodesia who was
a member of the church.
Rhodesia
was getting pressure because the white minority was ruling the
country and many of the residents were trying to leave because they
(correctly) saw that arrangement would not last and there was great
uncertainty about what would happen in a new government.
We
saw this gentleman years later (I was still young) and his parents
were then trying to leave Rhodesia. I remember absolutely nothing
from this conversation except that his parents were not able to take
their money with them out of the country. They could leave but the
money had to stay. This struck me as being completely unfair which
is why, I suppose, I remember the statement.
Thus
has it always been, and will always be, that corrupt dictating
central governments that create poor business environments restrict
the outflow of capital from their countries.
I
was reminded of this story with the news the past few weeks that
companies are using “inversions” to avoid some tax
liability to the U.S. Government.
An
inversion is where a large U.S. company buys a company that is
located in a country that has a lower tax rate for corporations and
then moves their company headquarters to the foreign country. Why
would a corporation do this? To reduce their tax liabilities and to
make the operations of the company easier and more simple.
The
company still has to pay taxes to the U.S. government for the profit
earned in the U.S. However, now with headquarters out of the U.S.,
the company would be able to collect the profits from all over the
world back to their headquarters.
The
U.S. is one of the few countries that taxes the profits of foreign
subsidiaries if the money is brought back into the U.S. (The
amount of this tax is the U.S. rate less the foreign taxes already
paid.) This policy has led to about $1,000,000,000,000 dollars of
U.S. company dollars sitting in foreign banks. This is really adds a
level of complexity to money management that is not needed and is
inefficient.
For
example, a company (U.S. based) I worked for financed many plants
being built in Central America with money from Luxemburg. The
Luxemburg money came from profits in Europe.
This
rush to use inversions has many in the government extremely nervous.
Looking at the above scenario it is not obvious, but once you know
how companies operate in real life the government has every reason to
be nervous.
Although
it is true that the U.S. company will still pay taxes on profits
earned in the U.S., it would now be easy to manipulate the amount of
profit earned through the use of loans from the foreign company
headquarters to the U.S. subsidiary and the use of dividends paid
from the U.S. subsidiary to headquarters.
Basically,
the profit made in the U.S. would be small on the U.S. books, with
the income shifted to a country that has a lower tax rate.
This
puts the $250 billion of annual corporate tax revenues in jeopardy.
The call to write tax laws to restrict or stop inversions is now
being heard from the Secretary of the Treasury to professors at
universities.
Inversions
are legal but that is not sufficient to make them ethical, so we need
to think about the ethics. There
are two competing ideologies to what is the civic responsibility of
corporations.
One
side sees the corporation as having its major responsibilities be to
their country and employees. They believe that the country where
they reside has provided them with the economic stability and
infrastructure that has allowed them to grow and be successful.
According
to this line of reasoning, the company should be willing to pay any
amount of tax asked by the government, and the company trying to
minimize their taxes is unpatriotic.
This
ideology also thinks that corporations have a major responsibility to
their employees. The employees are the ones that make the company
work and so they are entitled to a greater portion of the profits of
the company. (Remember Obama’s statement, “You did not
build that by yourself.”)
The
opposing view believes that corporations should maximize the
profitability of the company and then let the shareholders (owners)
decide what to do with the money they receive as dividends (this
creates maximum utility for the owners).
The
gulf between these two extremes is wide and deep, and to say there is
animosity on both sides is an understatement. This is the question
that is being proposed by the current administration who believe
fervently on side one while those on the right, as expressed by some
talk show hosts, believe in the other view.
I
think I have expressed both sides well enough and will now give my
views (which will be flagrantly moderate so disliked by both sides).
I
believe corporations do have civic responsibilities. It is easy to
think of some that we all can agree on like not polluting or not
knowingly producing products that create a safety hazard for
customers.
However,
I believe it goes beyond these obvious examples, such as spending
some of the money on the communities where they do business so an
entire city, county, or state is blessed by the company being located
there. I am not talking about extravagance, but it is amazing what a
moderate amount of targeted spending can do.
They
also have the responsibility to pay all the taxes that are lawfully
required. But it would be completely irresponsible for them to pay
enormous sums of money for taxes that could easily be avoided.
Imagine
having someone prepare your taxes and having them telling you that
they were not going to allow you to take the mortgage deduction
because it dropped you below a tax rate they thought appropriate for
your income and if you took the deduction it would be unpatriotic.
The
U.S. Government has put corporations in a tough position. If you
asked any of the CEOs that have moved their headquarters off-shore,
it is likely that all or almost all would rather keep their
headquarters in the U.S.
However,
they would really be shirking their fiduciary responsibility to the
owners of the company if they paid hundreds of millions of dollars
every year to the U.S. government that they could legally avoid and
give to the owners of the company.
The
government put the corporations in the bad situation, and it could
bail them out. I am always completely appalled when some powerful
politician criticizes a company for following the laws the politician
passed. You know you are hearing either a political hack or a moron
talking. Nobody ever asks the politicians why they passed a bad law
and what they are going to do to fix it.
Stopping
companies from leaving the U.S. would be really easy. Just work to
reform the corporate tax code so that the U.S. is competitive with
the rest of the world. We do not have to have the lowest tax rate —
just at least reasonably competitive.
This,
of course, will not happen because of the dysfunction in Washington,
even though there is wide bipartisan support for the reform. Let me
say that again, there is wide bipartisan support for reform.
So
why is the tax code not fixed? Politicians are getting money from
special interests. Yup, it is time to start using the C-word when
talking about our government.
Thus
has it always been, and will always be, that corrupt dictating
central governments that create poor business environments restrict
the outflow of capital from their countries.
Adam Smith is obviously not the actual name of the author of this column. The real author has
worked for two Fortune 500 companies, one privately held company, and a public accounting
firm. His undergraduate degree was in accounting, and he earned an MBA for his graduate
degree. He also has completed coursework for a PhD. in finance. He continues to be employed
by one of the Fortune 500 companies.
The author grew up in the Washington D.C. area but also lived for several years in Arizona. He
currently resides with his family on the East Coast.
The author has held various callings in The Church of Jesus Christ of Latter-day Saints.