Don't knock Minneapolis-based medical equipment maker Medtronic Inc. for doing the biggest tax inversion deal in U.S. history: It makes perfect sense for the company's shareholders. If it isn't a particularly patriotic move, that's because the U.S. is ignoring the obvious solution to its corporate emigration problem.
Tax minimization, of course, shouldn't be the prime reason for mergers and acquisitions. The megamerger of advertising giants Omnicom Group Inc. and Publicis Group SA, which fell apart last month after hitting tax approval hurdles, made no business sense -- so kudos to the tax authorities for breaking up that unhappy alliance. As the U.K.-based tax consultant Richard Murphy commented at the time: "Tax deals are made in hell."
Still, Medtronic's planned $42.9 billion takeover of Dublin-based Covidien Plc wouldn't crown a chain of such deals if they did not, as a rule, work. The data suggest U.S. companies that do tax inversions provide abnormal returns to shareholders -- about 225 percent above the average, Elizabet Chorvat of the University of Chicago found in a recent study of such deals from 1993 to 2013. A Bloomberg News analysis of 14 U.S. corporate expatriations since 2010 also showed that the companies involved mostly outperformed the market benchmark.
The knee-jerk response of U.S. politicians has been to stop companies from seeking to improve their returns to shareholders. President Barack Obama proposed in his 2014 budget that U.S. companies should only be allowed to redomicile abroad if a merger transaction gave more than 50 percent of their equity to foreign companies, up from the current 20 percent. The brothers Sander and Carl Levin -- a U.S. congressman and senator, respectively -- are pushing through a similar bill. This would essentially force U.S. companies to acquire foreign firms bigger then themselves if they want to invert. The deals would become more difficult to structure, perhaps requiring the breakup of some U.S. corporations, but that would not stop companies from doing them so long as there are clear gains to be made.
Apart from this counterproductive "stop thief" approach, there is the utopian idea of getting all developed countries to tax multinational companies on the basis of where they actually make money. Taxes would then be calculated of the basis of sales, labor costs and investments by country. The logic appeals to Europeans, especially the French, when it comes to U.S. tech companies, but there's no law saying all countries have to follow the same taxation principles.
The Irish, for one, could stand up for their 12.5 percent statutory corporate tax rate and leniency in calculating the tax base for major corporations such as Apple Inc. Ireland collects 2.6 percent of its gross domestic product in corporate tax, according to the Organization for Economic Cooperation and Development. The U.S., with its 39.1 percent statutory rate (including state and local taxes), only collected 1.6 percent of GDP in 2003. So which country is the low-tax jurisdiction?
Instead of devising ways to punish companies for trying to make more money -- closing the expatriation window or taxing foreign profits at U.S. rates -- the mighty U.S. should emulate little Ireland. Its case is one of the clearest examples of how a low tax burden results in improved collection and a friendly business climate. With a 12.5 percent corporate rate, there would be no incentive for multinationals to keep profits parked overseas and more mergers would take place in the U.S. There would be fewer tax-motivated "deals made in hell," too.
Until then, the Irish tax regime will remain one reason why U.S. and European companies are disproportionately interested in setting up residence on the island, resulting in political pressure from heavyweights such as the U.S. and Germany (which collects 1.8 percent GDP in corporate tax). If Ireland buckles and raises its corporate tax rates to please leaders in Washington and Berlin, some other jurisdiction will no doubt take its place to reap the same benefits. Rather than bully Ireland, the global economy's 800-pound gorillas should try cutting corporate tax rates themselves.
To contact the author of this article: Leonid Bershidsky at firstname.lastname@example.org.
To contact the editor responsible for this article: Marc Champion at email@example.com.