All Commentary
Tuesday, September 9, 2014

Where’s the Beef? Canada!

Love of country doesn’t mean one must also love the IRS

Burger King has acquired Tim Horton’s for $11.4 billion. While an optimist may hope this acquisition produces the donut technology needed for a mass-marketed Luther Burger, a realist has to acknowledge that it’s probably about corporate inversion.

Simply put, corporate inversion means a corporation reincorporates in a lower-tax country abroad. The common justification of taxation is that the government provides the public goods that business needs to prosper. But the United States is unique in that it taxes corporations at 35 percent regardless of where the income is earned, and hence regardless of whether the corporation benefited from any public goods.

Payment without benefit is simply bad business. Avoiding particularly high tax rates like those of the United States can yield significant savings for companies—and their shareholders. Charlotte-based Chiquita Brands International, for instance, hopes to save $60 million via its recent acquisition of Ireland-based Fyffes PLC. Burger King’s merger, according to analyst estimates, could cut its overall tax bill by 13 percent.

Not everyone is happy with this arrangement. In a poor imitation of Oliver Twist, the President condemns inversion, stating, “It damages the country's finances … It adds to the deficit. It makes it harder to invest in things like job training that help keep America growing. It sticks you with the tab to make up for what they're stashing offshore through their evasive tax policies.” 

Populist themes like “economic patriotism” may appeal to voters, but such arguments are nonsensical: Firms are ultimately responsible to their shareholders. As Judge Learned Hand wrote, “Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one's taxes.”

If anything, firms have a moral responsibility to minimize their taxable liabilities. The legal structure of a firm establishes the relationship between shareholders, who own the capital, and managers that make operating decisions. Executives have a fiduciary responsibility to pay the lowest tax possible because they are the stewards of their shareholders’ wealth. There is no functional difference between an executive who spends millions of dollars on a lavish party and an executive who gives that money to Washington instead—except that the former is probably a lot more fun to be around.

Think about tax compliance like a rent check owed to one’s landlord, with the added complication that it’s very difficult to move. Suppose a tenant is currently renting multiple apartments at one location, but decides the rent is just too damn high. Since the tenant can’t relocate entirely, suppose she moves some of her stuff out of one of the apartments into a storage unit across town, thus saving significantly on her rent. Would this be seen as unethical in that the tenant is attempting to avoid her fiduciary obligation to the landlord? Of course not. She is simply trying to reduce the costs of residing in a particular location.

In the same vein, minimizing the firm’s tax burden means minimizing part of the firm’s operating costs. Just as a resource manager can identify a more cost-efficient way to produce goods and services, so can a tax lawyer identify a more cost-efficient way of maintaining tax compliance. A business has no moral obligation to always use the same suppliers, be they suppliers of production inputs or corporate charters. The law is the law and firms have the option of changing how they are structured and located in order to minimize their taxable liabilities. If they use loopholes, so be it: Loopholes are by definition legal. Firms only have the obligation to pay the tax mandated by the law.

And it’s not just companies and shareholders who benefit; taxes raise prices for consumers. When a firm operates in a competitive environment, a reduction in tax rates translates into reduced prices for consumers. No one usually complains when firms find cheaper ways to produce and then pass these savings on to consumers. It is only a strange form of patriotism, driven largely by political interests, that equates love of country with the love of the IRS.

As long as government continues charging firms non-competitive tax rates, inversion will inevitably continue. Advances in telecommunication and information technologies have enabled a massive increase in firm size. Multinational firms are quite common now, and this technology increases their mobility. By choosing where they operate, firms are able to choose the legal regime they want to govern their affairs. After all, if a landlord tries to charge a higher rent than every other comparable property in town, they will soon find themselves without any tenants. The real scandal is that individuals may be able to shop around for better rents and landlords, but except for the very wealthy, are usually bound to the tax regime cooked up by their rulers.  

This competition among legal regimes is a powerful constraint on government—and that is a good thing for all of us. America has the second-highest corporate tax rate in the world—the highest when state taxes are included. The solution to this problem lies not in closing loopholes or imitating poor Oliver pleading for more, but in offering a simpler, more competitive tax system.

  • Adam C. Smith is an assistant professor of economics and director of the Center for Free Market Studies at Johnson & Wales University. He is also a visiting scholar with the Regulatory Studies Center at George Washington University and coauthor of the forthcoming Bootleggers and Baptists: How Economic Forces and Moral Persuasion Interact to Shape Regulatory Politics.
  • Stewart Dompe received his PhD in Economics from George Mason University. He has published articles in Econ Journal Watch and is a contributor to Homer Economicus: Using The Simpsons to Teach Economics. Follow him on Twitter @stewartdompe