Too Bad We're Number 1: High U.S. Corporate Tax Fuels Capital Flight
There’s something going on right now that doesn’t bode well for the long-term, sustainable growth of the American economy.
What’s driving my somewhat stark outlook? It’s the growing trend for American companies to consider relocating their headquarters outside the U.S. in order to take advantage of considerably lower business tax rates in other jurisdictions.
This has long been a practice on the radar for large multinational organizations, but small to medium size enterprises are now also increasingly considering this measure.
In the cases of the larger firms, as we have recently seen in the Burger King tax deal, amongst others, it typically involves inversions. Inversion is a process whereby a bigger organization targets and acquires a smaller firm that’s located in a more corporate tax-friendly country, with the deal structured so that the smaller company becomes the controlling partner of the larger firm. Although it has been reported by those close to the Burger King deal that its relocation to Canada is not primarily motivated for tax reasons, the move would empower the company to repatriate profits on its overseas business at a lower rate. As such, it can be reasonably assumed that tax efficiency was indeed an important consideration.
The whole concept of inversion, and the simpler relocation of smaller firms’ HQs, is driven by one simple desire – to avoid America’s corporate tax rate which headlines at 35 per cent, which is the highest corporate tax rate in the industrialized world.
My prediction that 2015 will be the year that the U.S economy could be defined by this phenomenon is based on deVere Group’s U.S. business-owning client base. The number of requests that we are receiving from them for more information about moving their registered business headquarters overseas is steadily growing.
In total, around 55 per cent of our American clients who own firms have already actively enquired about this issue in the last six months.
The figure isn’t static at 55 per cent, either. Recently we’ve seen a surge in enquiries which, I suspect, is due to the high profile publicity surrounding companies such as Burger King who have already undertaken inversion and the top-level political debate.
Should this trend really take hold, as I suspect it could, there’s a definite threat of a potential capital flight storm that could have far reaching consequences for the American economy. For instance, it can be reasonably assumed that investment would stall, which would hit productivity and subsequently wages, jobs, living standards and long-term economic growth.
There has been much furor over companies moving outside the U.S. for tax purposes. But, in all honesty, who can blame them? The idea of significantly and perfectly legally reducing annual tax liabilities in lower tax jurisdictions is a major temptation. The burden of comparatively high corporation tax is carried by investors through lower returns, workers through reduced wages and/or consumers through higher prices.
Related: Obama Takes Aim at Corporate Taxes
Let’s look at the latest figures on this issue.
The Tax Foundation recently published research that found America’s top rate of business tax – 35 per cent – is the highest amongst the 34 industrialized nations of the Organization for Economic Cooperation and Development (OECD).
Additionally, since the year 2000 all but three OECD countries – the U.S., Chile and Hungary – have reduced their corporate tax rate.
There are many examples from which I could draw comparisons, one being the UK. In Britain the corporate tax rate is just 21 per cent and the government is lowering it further to 20 per cent in 2015. This will position the UK’s corporate tax level as the joint lowest in the G20.
To me, and obviously to a substantial number of U.S. businesses both big and small, it is clear that unless America cuts its high business tax rate it will struggle to maintain a competitive edge and remain attractive for investment. As such, companies – and especially those with overseas earnings – will increasingly consider moving their registered address outside the U.S.
At this point it’s relevant to take a look at the concept of the Laffer Curve. Principally, the Laffer Curve is a representation of the relationship between rates of taxation and levels of government revenue. It demonstrates that there is a point at which increasing the rate of taxation becomes counterproductive to raising revenue.
This is what’s happening within the American economy at the moment and will, if unchecked, result in my prediction of a capital flight storm from 2015 onwards.
How can I be so certain? Our experience shows, and economic history demonstrates, that when companies and/or individuals become “taxed out”, many with the resources to do so will fiscally relocate elsewhere to mitigate their tax burden.
So how can this be stopped? I think, rather than threatening to use controversial presidential powers to prevent U.S. companies legally reducing their tax burden as has been mooted recently, Mr Obama must instead bring America’s corporate tax rate in line with the rest of the world’s developed economies.
By making America more attractive to domestic business, the world’s leading power will become more attractive, more competitive and more pro-business. And, by consequence, as we’ve seen demonstrated by the Laffer Curve, the States will rake in more corporate tax, not less.
I’ve found, talking to deVere’s many U.S. clients that most American companies do indeed want to remain headquartered in America but the tax situation is making it tough to justify doing so.
By reducing the rate of corporate tax and by America becoming more competitive compared to the rest of the developed world, this situation can be reversed. The solution to the serious and very real problem of capital flight sounds so simple doesn’t it? And it is.