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As more companies are taking steps to move their headquarters out of the U.S., Congress and President Obama have expressed outrage at this supposedly unpatriotic practice. Treasury Secretary Jack Lew has said that action needs to be taken, and 16 House Democrats have cosponsored a bill to make tax inversions more difficult. In short, a tax inversion is when a company relocates part of its operations to another country in order to avoid U.S. tax law.
But anger at companies for pursuing their economic interest is misplaced, and the regulations now being proposed to prevent tax inversions are exactly the wrong way for a country to encourage commerce and a vibrant economy. Here are the three main reasons why we shouldn’t worry so much about tax inversions.
1. They are a product of our corporate tax policy.
The United States has the highest corporate tax rates in the developed world - a total of 39.1 percent. Is it any wonder that corporations would try to escape this burden in favor of less onerous regulations? It is worth remembering that U.S. corporate tax rates were once globally competitive. As they have increased, however, we have seen more companies engaging in this sort of behavior.
The good news is that changes in behavior offer a good barometer to tell whether a policy is working. We don’t need expensive and time-consuming academic studies to tell that our tax policy needs to change. The increase in tax inversions offers all the clues we need to identify a policy failure.
In other words, allowing companies to relocate freely gives government an incentive to improve its policies. As Art Laffer famously observed, if they want to maintain tax revenues, they will ultimately have to lower rates and create an environment more friendly to employers.
Unfortunately, rather than recognize this truth, Congress would prefer to pass laws penalizing companies for relocating. Despite the totalitarian overtones of laws designed to effectively imprison business within our borders, does it make any sense to counter behavior caused by punitive taxes by making taxes more punitive still?
It does not.
2. Inversions don’t hurt the American economy.
Economists have long recognized the benefits from trade, with David Ricardo mathematically demonstrating centuries ago that there are always gains from specialization and exchange. It is therefore puzzling that so many people still view “foreign” companies as somehow threatening to the American economy.
It’s important to remember that Americans still pay for goods with U.S. dollars, regardless of where the company in question is located. U.S. dollars cannot be spent in England, or China, or Russia, but only in America (and a handful of protectorates.) This means that what an American buys something from a foreign company,that money ultimately has to come back to an American producer - it simply cannot be spent anywhere else.
The only effect tax inversions have on the American economy is to deprive the government of tax revenue, which is why lawmakers have been expressing such vocal outrage.
3. Competition makes everything better.
The purpose of federalism, in which different states and localities are permitted to make their own laws, is to encourage competition between policies. If tax rates are too high in Vermont, you can always move to Texas. In this way, the states have been referred to as “laboratories of democracy.”
But sometimes, the federal government passes laws that govern all the states equally - laws like the corporate tax rate. In this case, there is no chance for people to vote with their feet, at least not domestically. That’s why it’s important to allow people the freedom to leave countries when they become dissatisfied with government policies.
Just as competition between firms results in lower prices and better products for consumers, competition between countries to attract business results in better economic policies that will lead to stronger growth and more freedom.