This won't cure inversions. Lower Taxes will. Source: Salix Pharmaceuticals Ltd. via Bloomberg
This won't cure inversions. Lower Taxes will. Source: Salix Pharmaceuticals Ltd. via Bloomberg

U.S. Treasury Secretary Jack Lew admits that the way to stop U.S. companies from reincorporating overseas is to lower the corporate tax rate and simplify the tax system. As ever, there's a "but": Lew wants Congress to ban tax inversions, as the practice is known, rather than pursue the correct solution from the start.

Inversions are certainly on the rise. As Congressman Sander Levin, who has sponsored legislation against the practice, said in a recent statement, "barely a week seems to pass without news that another corporation plans to move its address overseas simply to avoid paying its fair share of U.S. taxes." Here's a chart from Levin showing that more U.S. companies have inverted in the past decade than in the previous two:

The latest inversion created a new Italian billionaire. Mauro Ajani's Cosmo Pharmaceuticals SpA, listed in Switzerland, sold $2.7 billion worth of patents to Salix Pharmaceuticals Ltd., based -- reluctantly -- in Raleigh, North Carolina. The sale takes the form of a merger between Salix and a Cosmo subsidiary, allowing the U.S. company to redomicile in Ireland. Salix chief executive officer Caroline Logan says this will let the firm reduce its long-term tax rate to a bit more than 20 percent from more than 30 percent currently. Otherwise, nothing much will change. "Everything that currently happens in Raleigh will continue to happen in Raleigh," Logan assured employees in a memo.

Salix is not a large company and can't expect Irish authorities to cut it any special slack, as the nation apparently does for tech giants such as Apple. It's worth moving to Ireland even to pay the statutory rate.

Lew calls this unpatriotic. "What we need as a nation is a new sense of economic patriotism, where we will rise or fall together," he wrote in a letter to Congress Ways and Means Committee Chairman Dave Camp, first published by The Wall Street Journal. Companies that reincorporate overseas still benefit from U.S. infrastructure, such as the American system for protecting property rights. The patents bought by Salix were U.S. ones, after all. So why shouldn't they pay U.S. taxes to maintain the country's excellent business climate?

The problem with that argument is that the infrastructure and business backdrop aren't consequences of the tax rate, and lowering that would increase the appeal of the U.S. as a place to do business. Lew would like corporate executives to extend their appreciation of America as a business environment to the government and its idiosyncrasies, and that's not an obvious leap. Invoking "economic patriotism" is very French, but the U.S. has a welcoming corporate environment precisely because it is not dirigist France.

Lew acknowledges that "the way to address this situation is through business tax reform that lowers the corporate rate, broadens the base, closes loopholes, and simplifies the system." There's a "but", of course: "But, even as we work to do that, we should prevent companies from effectively renouncing their citizenship to get out of paying taxes."

Lew calls on legislators to pass bills proposed by Sander Levin and his brother Carl, a senator, and make them retroactive to May 2014. The proposed legislation will make an inversion inadmissible for U.S. tax purposes if the merged company is more than 50 percent owned by "historic shareholders of the U.S. corporation". The current threshold is 80 percent.

The Salix deal could fall under the new legislation. Cosmo gets 19.4 million shares in the new Salix out of 63.4 million -- a 30.6 percent stake. Perhaps investors are wary of the legislation's potential impact: Salix stock is down 2.4 percent since the announcement after rising quickly for months before. Would Salix, however, cancel the deal or go back to paying a higher tax rate if the Levin brothers' bills were enacted? No, it would probably restructure the deal so Cosmo, which holds additional patents for medicines released gradually as a tablet travels through a patient's colon, gets a bigger stake.

There's no point introducing ineffective stopgap measures if the goal is to stop tax inversions. Both Lew and U.S. executives would be happy if the corporate tax rate were lowered to make the U.S. more globally competitive in a world where national borders mean less and less. That, then, is the issue that legislators should tackle urgently.

To contact the author of this article: Leonid Bershidsky at lbershidsky@bloomberg.net.

To contact the editor responsible for this article: Mark Gilbert at magilbert@bloomberg.net.