Wednesday, August 27, 2014

Tax Inversion v. Tax Evasion


As we understand it (as it was brought forcibly to mind with the Great Tim Horton’s v. Burger King Controversy . . . Timbits, anyone?), if a U.S. company moves its headquarters to another country, it can pay corporate income taxes at a lower rate.  Given that the United States now ranks number one of countries in the industrialized world with high corporate tax rates, this is a great incentive to move (even more) industry out of the country.

Critics are characterizing this “tax inversion” (as it is called) as a form of tax evasion.  That’s a little harsh.  Tax evasion means someone is violating the law and not paying what he, she, or it owes.  Tax inversion is properly “tax avoidance,” which is perfectly legal.

If you’ve ever taken a tax course, you know that there are often many ways of doing something or structuring a transaction to minimize the tax hit.  It might not be “right,” but it is legal.  If you object, the proper response is not to try and figure out some way to penalize people taking advantage of tax provisions or loopholes, but to amend the tax code.

Of course, as with anything, you have to be very careful when passing laws.  As the great constitutional scholar Albert Venn Dicey pointed out over a century ago, if “public opinion” is not behind a law, and if the law is not carefully written to reflect public opinion, any law will either be unenforceable, or will have substantially different results than what was intended.

A few examples will illustrate this point.  At one time, railroad rates were as low as possible on long runs where there was enough traffic to support competition, but as high as possible on short runs where there was much less demand.  People thought that was wrong, so Congress passed a law mandating that rates on short runs had to be commensurate with the rates on long runs.  This did not, however, lower the rates on short runs.  It raised the rates on long runs, removed the incentive to compete efficiently and effectively, and undermined the viability of America’s railroads.

More beneficially, the Fugitive Slave Act of 1850 had little popular support, and was the most disobeyed law in U.S. history until Prohibition.  Prohibition?  It gave organized crime an immense amount of power, and even legitimized it to a certain degree by criminalizing an activity that most Americans simply didn’t think was wrong.

So what is the solution to tax inversion?

In the short term, require that all corporations doing business in the United States pay corporate taxes where the profits are generated, not where the corporation is “domiciled.”  Is that fair?  People don’t have to do that, do they?  Isn’t it unconstitutional to tax somebody when they don’t live there?

That’s a non-issue.  Corporations aren’t human beings, that is, natural persons.  Corporations are “artificial persons.”  Corporations therefore only have such rights as the law or their owners give them.  Constitutions only cover natural persons, not creatures of law such as corporations, labor unions, or any other type of organization including the State itself, except when artificial persons are specified.

In the long term, the solution is to make it possible to eliminate corporate taxes altogether.  Oh, not by eliminating corporate taxation, of course.  The rate, in fact, should be raised.

No, make it possible for a corporation to eliminate corporate income taxes by making dividends tax deductible.  This will encourage full payout of dividends to avoid taxes.

If a corporation needs to expand, then it should issue new shares — which should be easy, as everyone will want shares that pay out all earnings.  If everyone can purchase newly issued shares on credit, and pay for the shares with the dividends paid in the future, everyone can own capital without taking capital from current owners.

This, essentially, is the proposal known as “Capital Homesteading.”  It would completely eliminate the tax inversion problem, because who is going to complain that a corporation isn’t paying any taxes, anyway?

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