In the "gimmick economy," it's not about good products or labor, but something far more scary.
September 24, 2014
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Treasury Secretary Jack Lew’s announcement of a series of new rules
to reduce the financial incentives behind corporate inversions tells you
a lot about where our economy sits right now. Productivity and growth
scarcely matter as much as what I would call the “gimmick economy.”
Companies now spend an inordinate amount of time figuring out not how to
beat their competition, but how to prosper from tricks and loopholes
their accountants find buried in the law. Every corporation has become,
at the root, a financial company, adept at moving money around on paper
and little else. And the government has to scramble in a never-ending
race to keep up with the innovations.
To start with, understand
what a corporate inversion is: an on-paper transaction involving a
merger between a larger U.S. company and a smaller counterpart abroad.
No worker moves overseas as a result of the merger. No production
facilities or corporate offices transfer. Instead, the address on the
corporate masthead changes from America to the low-tax alternative where
the overseas company is headquartered. It’s a completely fictitious
pretension, no different than if I used a handicapped placard to park in
good spots everywhere I went, and then limped around after getting out
of the car.
CEOs claim that America’s burdensome 35 percent
corporate tax rate forces them to be creative, and in absence of
fundamental tax reform, they must reluctantly renounce their corporate
citizenship to stay competitive with their overseas counterparts. First
of all, in actuality, corporate taxes are not much of a burden; thanks
to all the loopholes and credits, corporations pay on average a
12.6 percent tax rate,
according to a 2013 Government Accountability Office paper. Second, by
that logic, if I think a bank vault unfairly denies me access to lots of
money, I should be allowed to use creative strategies to bust it open.
In reality, corporations’ reasons to invert have nothing to do with staying competitive, as USC law professor Ed Kleinbard
explained in a recent paper. It’s merely about preventing the unintended consequences of one gimmick, by loading up on another gimmick.
You see, multinational corporations have
more than $2 trillion parked
offshore, money that was either earned through foreign subsidiaries, or
from a series of tax-sheltering strategies. That money, in theory,
cannot be transferred to their American operations – in particular, to
reward executives and shareholders – without paying a tax. Corporations
therefore defer repatriating these profits, and the money remains
“trapped” overseas, although the bulk of it is actually invested in
things like Treasury bonds, earning modest interest amid the tax
avoidance.
Corporations first tried to deal with this through
public whining, claiming that they could not reinvest in America without
bringing this money home tax-free. In 2004, Congress
approved a tax amnesty on
offshore cash, but the $300 billion repatriated did not go to
investment or growth, but mostly to stock buybacks and dividends to
goose share prices.
The 2004 amnesty led corporations to assume
that they could simply stockpile money out of the U.S., and beg Congress
for another reprieve. But Congress, incredibly, learned a lesson, and
never allowed repatriation again.
So inversions became a second
option for trying to unlock overseas cash. Once corporations establish a
headquarters offshore, they can basically funnel money into it to avoid
taxes, in a number of ways. They can make loans from the offshore cash
into their new foreign parent company, “hopscotching” the U.S. tax
system. They can
strip earningsfrom
their domestic operations and, through accounting tricks, pretend they
were earned overseas, again passing them along to the foreign parent.
They can spin out their assets to a shell company built in a tax haven
(known as a “spinversion”) to facilitate the earnings stripping and
hopscotch loans.
In all cases, the goal is to get as much money
into the lowest tax treatment as possible. And it won’t surprise you to
know that Wall Street, which facilitates all these mergers,
makes a tidy profit in the exchange, nearly a billion dollars in the past three years.
With the
new regulations announced
Monday, the Treasury Department will attempt to stop some of these
transactions, though not all of them. The rules attack hopscotch loans
by making the inverted company liable for taxes when they try to take
deferred profits from a subsidiary. They prevent pass-throughs of stock
or property into foreign parent companies to avoid taxation. And they
try to prevent spinversions into a third-party shell corporation. But
Treasury did not try to reduce incentives for
earnings stripping, the ways in which inverted companies shift money into the foreign parent and lower the tax bill on their U.S. earnings.
Victor
Fleischer, a tax law professor at the University of San Diego, told
Salon, “It should shut down a few deals but not all. It’s not as
aggressive as the Treasury could have been, but far better than doing
nothing.” You’ll be shocked to learn that the Obama administration found
a middle path on a policy.
You can read
tons of
articles debating the
administration’s anti-inversion
strategy.
But let’s look at the big picture of what these inversions signify.
Corporations, at great effort and expense, have figured out how to
pretend to be domiciled overseas to save money. The government, through
similar effort and expense, cuts off some of the benefits. Presumably
what happens next is that corporations engage in another round of
scouring the tax code for some other way to profit.
And government has
to chase that. And so on.
Tax dodges are as old as the republic.
But I seem to remember a time when selling a half-decent product was the
pathway to corporate riches.
Since the 1980s,
however, large corporations, from Google to GE, have fundamentally
become financial firms, using sophisticated techniques to manage their
cash.
Sometimes that involves
parking money offshore;
sometimes it involves interest-rate swaps or other derivatives;
sometimes it involves using debt to finance operations because it offers
better tax advantages than equity; sometimes it involves using
stock buybacks or
real estate sales to simulate better corporate performance.
So
many resources go to financial engineering that research and
development or capital investment, things that circulate money through
an economy, ends up withering. The gimmick economy values tax arbitrage
or pretend growth to actually out-achieving business competitors. The
stock price, and how to game it, becomes an end goal for executives who
are typically paid based on how well the stock performs. CEOs with
backgrounds in investment banking become more valuable than those with
experience in the corporation’s actual industry.
This myopic
preference of the short-term over the long-term goes a long way to
explaining why we have a Main Street economy with stagnant wages, weak
job security and an inability to get ahead. All the money gets tied up
in financial game-playing to goose short-term values. And the powerful
actors who created this system don’t want it to change.
Congress
can end this gimmick on inversions by deciding that, if a company is
managed in the United States, it’s American, regardless of the address
on the letterhead. Hilariously, they may get it done by threatening a
bunch of other corporate gimmicks. Corporations want Congress to
retroactively extend a bunch of tax breaks that expired at the end of
2013 in the lame-duck session.
Democrats may
link those tax extenders to anti-inversion legislation, forcing corporations to choose between which set of tax breaks they want to keep.
But
the larger point holds. Until we end this over-financialization that
has crept into every aspect of our economy, corporations will simply
move from one gimmick to the next.
David Dayen is a
contributing writer to Salon who also writes for The New Republic, The
American Prospect, Politico, The Guardian and other publications. He
lives in Los Angeles. Follow him on Twitter: @ddayen
