[Senate Hearing 113-584]
[From the U.S. Government Publishing Office]
S. Hrg. 113-584
THE U.S. TAX CODE:
LOVE IT, LEAVE IT, OR REFORM IT
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HEARING
before the
COMMITTEE ON FINANCE
UNITED STATES SENATE
ONE HUNDRED THIRTEENTH CONGRESS
SECOND SESSION
__________
JULY 22, 2014
__________
Printed for the use of the Committee on Finance
______
U.S. GOVERNMENT PUBLISHING OFFICE
93-597 PDF WASHINGTON : 2015
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Washington, DC 20402-0001
COMMITTEE ON FINANCE
RON WYDEN, Oregon, Chairman
JOHN D. ROCKEFELLER IV, West ORRIN G. HATCH, Utah
Virginia CHUCK GRASSLEY, Iowa
CHARLES E. SCHUMER, New York MIKE CRAPO, Idaho
DEBBIE STABENOW, Michigan PAT ROBERTS, Kansas
MARIA CANTWELL, Washington MICHAEL B. ENZI, Wyoming
BILL NELSON, Florida JOHN CORNYN, Texas
ROBERT MENENDEZ, New Jersey JOHN THUNE, South Dakota
THOMAS R. CARPER, Delaware RICHARD BURR, North Carolina
BENJAMIN L. CARDIN, Maryland JOHNNY ISAKSON, Georgia
SHERROD BROWN, Ohio ROB PORTMAN, Ohio
MICHAEL F. BENNET, Colorado PATRICK J. TOOMEY, Pennsylvania
ROBERT P. CASEY, Jr., Pennsylvania
MARK R. WARNER, Virginia
Joshua Sheinkman, Staff Director
Chris Campbell, Republican Staff Director
(ii)
C O N T E N T S
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OPENING STATEMENTS
Page
Wyden, Hon. Ron, a U.S. Senator from Oregon, chairman, Committee
on Finance..................................................... 1
Hatch, Hon. Orrin G., a U.S. Senator from Utah................... 3
WITNESSES
Stack, Robert B., Deputy Assistant Secretary for International
Tax Affairs, Department of the Treasury, Washington, DC........ 5
Saint-Amans, Pascal, director, Centre for Tax Policy and
Administration, Organisation for Economic Co-operation and
Development, Paris, France..................................... 7
Desai, Mihir A., Ph.D., Mizuho Financial Group professor of
finance, and professor of law, Harvard University, Cambridge,
MA............................................................. 9
Merrill, Peter R., Ph.D., director, National Economics and
Statistics Group, PricewaterhouseCoopers, Washington, DC....... 11
Robinson, Leslie, Ph.D., associate professor of business
administration, Tuck School of Business, Dartmouth College,
Hanover, NH.................................................... 13
Sloan, Allan, senior editor at large, Fortune magazine, New York,
NY............................................................. 14
ALPHABETICAL LISTING AND APPENDIX MATERIAL
Desai, Mihir A., Ph.D.:
Testimony.................................................... 9
Prepared statement........................................... 37
Hatch, Hon. Orrin G.:
Opening statement............................................ 3
Prepared statement........................................... 40
Levin, Hon. Carl:
Prepared statement........................................... 43
Merrill, Peter R., Ph.D.:
Testimony.................................................... 11
Prepared statement........................................... 46
Robinson, Leslie, Ph.D.:
Testimony.................................................... 13
Prepared statement........................................... 63
Saint-Amans, Pascal:
Testimony.................................................... 7
Prepared statement........................................... 74
Sloan, Allan:
Testimony.................................................... 14
Prepared statement with attachment........................... 81
Stack, Robert B.:
Testimony.................................................... 5
Prepared statement........................................... 96
Thune, Hon. John:
Prepared statement........................................... 101
Wyden, Hon. Ron:
Opening statement............................................ 1
Prepared statement........................................... 102
Communications
American Citizens Abroad (ACA)................................... 105
The Babcock and Wilcox Company (B&W)............................. 109
National Association of Manufacturers............................ 111
National Retail Federation (NRF)................................. 114
Public Citizen................................................... 115
Reforming America's Taxes Equitably (RATE) Coalition............. 121
Silicon Valley Tax Directors Group............................... 125
Steelcase Inc.................................................... 131
THE U.S. TAX CODE:
LOVE IT, LEAVE IT, OR REFORM IT
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TUESDAY, JULY 22, 2014
U.S. Senate,
Committee on Finance,
Washington, DC.
The hearing was convened, pursuant to notice, at 9:50 a.m.,
in room SD-215, Dirksen Senate Office Building, Hon. Ron Wyden
(chairman of the committee) presiding.
Present: Senators Schumer, Stabenow, Menendez, Cardin,
Brown, Hatch, Grassley, Enzi, Thune, Burr, Portman, and Toomey.
Also present: Democratic Staff: Michael Evans, General
Counsel; Todd Metcalf, Chief Tax Counsel; Jocelyn Moore, Deputy
Staff Director; and Joshua Sheinkman, Staff Director.
Republican Staff: Chris Campbell, Staff Director; Tony
Coughlan, Tax Counsel; Chris Hanna, Senior Advisor for Tax
Reform; Jim Lyons, Tax Counsel; Shawn Novak, Senior Accountant
and Tax Advisor; Mark Prater, Deputy Staff Director and Chief
Tax Counsel; and Jeff Wrase, Chief Economist.
OPENING STATEMENT OF HON. RON WYDEN, A U.S. SENATOR FROM
OREGON, CHAIRMAN, COMMITTEE ON FINANCE
The Chairman. The Finance Committee will come to order.
The U.S. tax code is infected with the chronic diseases of
loopholes and inefficiency. These infections are hobbling
America's drive to create more good-wage, red, white, and blue
jobs here at home. They are a significant drag on our economy
and are harming U.S. competitiveness. The latest outbreak of
this contagion is the growing wave of corporate inversions,
where American companies move their headquarters out of the
United States in pursuit of lower tax rates.
The inversion virus now seems to be multiplying every few
days. Medtronic, Mylan, Mallinckrodt, and many more deals have
either occurred recently or are currently in the works.
Medtronic's proposed $42-billion merger with Covidien was
record-breaking when it was announced in June. But the ink in
the record book had barely dried when AbbVie announced its
intention on Friday to acquire Shire for almost $55 billion.
According to the July 15th edition of Marketplace, and I am
going to quote here, ``What's going on now is a feeding frenzy.
. . . Every investment banker now has a slide deck that they're
taking to any possible company and saying, `You have to do a
corporate inversion now because, if you don't, your competitors
will.' ''
The Congress has been aware of the inversion virus for a
long time. In fact, it passed legislation purporting to solve
the problem a decade ago. But the underlying sickness continues
to gnaw away at our economy with increasing intensity.
The American tax code is an anticompetitive mess.
Accountants, lawyers, and fast-buck artists looking for tax
shelters feed off it. This mess is driving American investment
dollars overseas, and, according to the Joint Committee on
Taxation,* it is costing American taxpayers billions.
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* For more information, see also, ``Present Law and Background
Related to Proposals to Reform the Taxation of Income of Multinational
Enterprises,'' Joint Committee on Taxation staff report, July 21, 2014
(JCX-90-14), https://www.jct.gov/publications.html?func=startdown&
id=4656K.
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On a bipartisan basis, the Finance Committee must respond
now. First, let us work together, colleagues, to immediately
cool down the inversion fever. The inversion loophole needs to
be plugged now. Second, let us use the space created by these
immediate steps to apply the indisputable, ultimate cure:
comprehensive tax reform.
Now, I have 9 long years of sweat equity in the cause of
tax reform. With former Senator Gregg and current Senators
Begich and Coats, we have produced what still is the Senate's
only bipartisan Federal income tax overhaul in almost 30 years.
Now, I would be the first to say that Senators here have
differing views about how to go about enacting tax reform. Let
us, however, recognize that what really counts is that the
Finance Committee is not back here once again discussing
inversions a decade from now.
Comprehensive tax reform has to happen soon. The outbreak
of inversions shows that, without curing the disease once and
for all, the illness is going to keep plaguing the American
economy. It is going to get tougher to create those good-wage,
red, white, and blue American jobs. Our tax base is going to
keep eroding. Cash piles trapped overseas will grow. Investment
will be driven elsewhere.
Now, the Finance Committee invited a number of CEOs from
the inverting companies to join our discussion today. None
accepted our invitation. I hope that these executives will soon
change their minds and be willing to answer questions that
Finance Committee members have about this issue.
The fact is, without immediate comprehensive tax reform, an
antidote to the inversion virus is needed now to protect the
American economy. This wave of inversions may be good for
shareholders and investment bankers and private equity firms,
yet the barrage is bad for America. America's free enterprise
system is at its best when there is a level playing field, and
inversions bestow tax favors on some parties that further
distort the free market.
Absent tax reform being enacted immediately, colleagues,
what happens if the inversion virus leads to 20 more inversions
over this summer? Many inversions to this point have happened
in the medical field, but the Wall Street Journal just reported
that there is evidence of inversions spreading to manufacturing
and retail.
How many more infections can America's economic body
endure? Global markets are expanding. Stockpiles of cash
sitting overseas grow at record levels. Foreign competitors get
more aggressive in chomping at the bit to get a deal on the
backs of the American taxpayer. The time for action is now. Our
committee needs to move on a bipartisan basis to close the
loopholes that are fueling the growth of the inversion virus.
Then the Finance Committee needs to cure the disease once and
for all with comprehensive tax reform.
I just want all colleagues to know that I am going to be
working with each of you on a bipartisan basis to accomplish
both of these tasks.
[The prepared statement of Chairman Wyden appears in the
appendix.]
The Chairman. Let me recognize my colleague and friend,
Senator Hatch.
OPENING STATEMENT OF HON. ORRIN G. HATCH,
A U.S. SENATOR FROM UTAH
Senator Hatch. Thank you, Mr. Chairman.
I appreciate you holding today's hearing. I think we can
all agree that addressing the shortcomings of our international
tax system is a critical step on the road toward comprehensive
tax reform. And, as we consider reforms to our tax code, our
primary goals should be to make the U.S. a better place to do
business and to allow American companies to more effectively
compete with their foreign counterparts in the world
marketplace.
Sadly, when it comes to our international tax system, much
of the attention gets placed elsewhere. For example, in 2013
the OECD launched its Base Erosion and Profit-Shifting, or
BEPS, project. While we appreciate the OECD's efforts at
bringing tax authorities together to discuss and work through
issues, many of us have expressed concern that the BEPS project
could be used by other countries as a way to increase taxes on
American taxpayers.
The issues under negotiation with the BEPS project are
complex and can have far-reaching and negative consequences.
And, while I think we should be willing to work through these
issues until an international consensus is reached, we should
not be rushed into accepting a bad deal just for the sake of
reaching an agreement.
I think we are right to expect that the Treasury Department
will aggressively represent American employers and their
workers in the BEPS negotiations, while responsibly consulting
with Congress as the discussions proceed. Hopefully, in the
end, the focus of these discussions will return to base erosion
principals instead of ways foreign countries can raid the
American Treasury or American businesses.
Of course, while the BEPS negotiations are important, the
most high-profile international tax issue today happens to be
corporate inversions. It seems that almost every day we are
hearing about a U.S. multinational opting to invert to a
foreign jurisdiction. As I have said publicly on multiple
occasions, I am greatly concerned about these corporate
inversions. Ultimately, the best way to solve this problem will
be to reform our corporate and international tax system in a
manner that will make our multinationals competitive against
their foreign counterparts. That will mean, among other things,
a significant reduction in the corporate tax rate and major
changes to make our international tax system more competitive.
Over the past few months, we have seen a handful of
legislative proposals to address the issue of inversions. Most
of them are punitive and retroactive. Rather than incentivizing
American companies to remain in the U.S., these bills would
build walls around U.S. corporations in order to keep them from
inverting. I think that is not only stupid, I think it is going
to result in consequences that nobody wants.
This approach, in my view, completely misses the mark.
While it may put a stop to traditional inversions, it could
actually lead to more reverse acquisition inversions, as our
U.S. multinationals would under this approach become more
attractive acquisition targets for foreign corporations.
Whether it is traditional corporate acquisition inversion or a
reverse acquisition inversion, the result is the same:
continued stripping of the U.S. tax base.
In fact, the approach in the proposed anti-inversion
legislation is so misguided it reminds me of an old joke. A
drunk is looking for something under a street light. A police
officer walks up to him and asks what is he looking for. The
drunk says, ``My keys.'' The police officer helps the drunk
look for a few minutes without success and finally asks, ``Did
you lose your keys here?'' The drunk says, ``No, I lost them
across the street.'' The officer responds, ``Then why are you
looking for them on this side of the street?'' The drunk
replies, ``Because the light is better over here.''
Once again, the ultimate answer to this problem--and the
only way to completely address the issue of inversions--is to
reform our tax code. However, as I have also said publicly,
there may be steps that Congress can take to at least partially
address this issue in the interim. And, while I do not support
the anti-inversion bills we have seen thus far, I personally am
open to considering alternative approaches, although I do have
a few stipulations as to what proposals I will consider.
For example, whatever approach we take, it should not be
retroactive or punitive, and it should be revenue-neutral. Our
approach should move us toward or at last not away from a
territorial tax system and should not enhance the bias to
foreign acquisitions. Most importantly, it should not impede
our overall progress toward comprehensive tax reform. Toward
that end, it should not be inconsistent with our House
colleagues' approach.
I think there is a growing chorus out there among some of
my friends on the other side of the aisle to use corporate
inversions as a political wedge issue in this election year. In
fact, I was recently the recipient of a very politically toned
letter from Treasury Secretary Lew on this issue. I hope that
is not the direction we take. If we actually want to accomplish
something on this issue, we are going to have to work together.
As you can see, Mr. Chairman, we have a lot to discuss
today.
I want to thank you for holding this important hearing, and
I look forward to hearing from this very distinguished panel.
The Chairman. Thank you very much, Senator Hatch.
[The prepared statement of Senator Hatch appears in the
appendix.]
The Chairman. Let me just reiterate that I am very much
interested in working with you and our colleagues on both sides
of the aisle to address both of these issues: the immediate
challenge we are facing with this growing inversion virus and
then, of course, the ultimate cure, which is comprehensive tax
reform. So I look forward to working with you and our
colleagues.
We now have six witnesses. Our first witness is Mr. Robert
Stack, who is the Deputy Assistant Secretary for International
Tax Affairs at the Treasury Department.
Our next witness will be Mr. Pascal Saint-Amans, director
of the Centre for Tax Policy and Administration at the
Organisation for Economic Co-operation and Development.
Our third witness will be Dr. Mihir A. Desai, who is
professor of finance at Harvard Business School and a professor
of law at Harvard.
Our fourth witness will be Dr. Peter Merrill, who is the
director of the National Economics and Statistics Group at
PricewaterhouseCoopers.
Our fifth witness will be Dr. Leslie Robinson, who is an
associate professor of business administration at the Tuck
School of Business at Dartmouth.
Our final witness will be Mr. Allan Sloan, who is the
senior editor at large for Fortune magazine.
Our thanks to all of you for coming. It is our custom that
your prepared statements will be made a part of the hearing
record in their entirety, and, if you could use your 5 minutes
to summarize, that would be very helpful.
I know Senators have many questions. We are going to have
some votes at 10:45. So this is going to be a bit of a juggling
act, and we will try to handle this as well as the chaotic
Senate schedule allows.
So, Mr. Stack, welcome.
STATEMENT OF ROBERT B. STACK, DEPUTY ASSISTANT SECRETARY FOR
INTERNATIONAL TAX AFFAIRS, DEPARTMENT OF THE TREASURY,
WASHINGTON, DC
Mr. Stack. Thank you, Chairman Wyden, Ranking Member Hatch,
and distinguished members of the committee. I appreciate the
opportunity to appear today to discuss these important
international tax issues to which your committee has already
devoted substantial effort.
I would like to begin by describing the work we are doing
in the G-20/OECD Base Erosion and Profit-Shifting, or BEPS,
project and then link that discussion to a consideration of the
need for international tax reform, as well as measures outlined
in the administration's fiscal year 2015 budget proposals to
address U.S. base stripping, including through so-called
inversion transactions.
In June 2012, at the G-20 Summit in Las Cabos, Mexico, the
leaders of the world's largest economies identified as a
significant concern the ability of multinational companies to
reduce their tax bills in high-tax countries by shifting income
into low- and no-tax jurisdictions. The result was the G-20/
OECD BEPS project and the BEPS action plan endorsed by G-20
leaders last September in Saint Petersburg.
The BEPS action plan outlines 15 specific areas where
governments need to work to change the tax rules that encourage
companies to shift their income at the expense of the global
tax base and our own tax base. The BEPS project is expected to
release its first set of recommendations this fall and is set
to conclude its work with final recommendations at the end of
2015.
The United States has a great deal at stake in the BEPS
project and a strong interest in its success. Our active
participation is crucial to protecting our own tax base from
stripping by multinational companies. Because the United States
provides a foreign tax credit to U.S. companies for taxes they
pay overseas, the United States also has a strong interest in
rules that enjoy a broad international consensus. In addition,
as home of some of the world's most successful and vibrant
multinationals, we have a stake in ensuring that companies and
countries play by tax rules that are clear and administrable
and that companies can avoid unrelieved double taxation, as
well as time-consuming, expensive tax disputes. Failure in the
BEPS project could well result in countries taking unilateral,
inconsistent actions, thereby increasing double taxation, the
cost to the Treasury, and the number and expense of tax
disputes.
I am happy to report that the OECD BEPS project has had a
promising beginning, and there are areas where commendable work
is being done to resolve gaps in existing international rules.
I have outlined those areas in my written submission. As the
work moves into 2015, there is more that can be achieved and,
also, several areas where we must guard against bad outcomes.
And echoing Senator Hatch, those bad outcomes would include
international norms that increase tax disputes because they are
vague and easily manipulated by tax authorities, or
international norms that could erode the U.S. tax base or
increase double taxation.
The United States needs to remain deeply engaged in moving
the BEPS project to a successful conclusion between now and the
end of 2015. While the international discussions over BEPS are
ongoing, it is worth acknowledging steps the United States
could take today to reform our own tax system to improve
competitiveness, secure our tax base, and reduce incentives for
profit-shifting by U.S. firms.
As the President has proposed, we should reform our
business tax system by reducing the rate, broadening the base,
and imposing a minimum tax on foreign earnings. But such reform
would only be a start, because, even with lower U.S. rates,
U.S. multinationals would continue to aggressively seek ways to
lower their tax bills by shifting income out of the United
States.
So what tools do we have at our disposal? The
administration's fiscal year 2015 budget contains a series of
common-sense proposals to protect our U.S. tax base which can
be enacted as part of reform or in the context of our current
system. They are outlined in some detail in our budget and in
my written testimony, but let me highlight just two here.
One proposal would strengthen our interest-stripping rules
and level the playing field by limiting the ability of U.S.
subsidiaries of a foreign multinational to deduct a
disproportionate amount of the group's global interest expense
to the United States. It is especially disconcerting to observe
that among the foreign multinationals that can most
aggressively take advantage of the deficiencies in our
interest-stripping rules are so-called inverted companies--that
is,
foreign-parented companies that were previously U.S.-parented.
A second proposal in our budget would deal with inversions.
As underscored by Secretary Lew's July 15th letter to Congress,
I want to emphasize the serious need for the United States to
directly address the potential loss of Federal tax revenue from
corporate inversion transactions and the need to enact our
budget proposal or a similar one aimed at curbing them.
Once companies invert, there is a permanent loss to the
U.S. income tax base, since it is safe to assume these
companies are not coming back to the United States. These
inversion transactions are on the increase and, indeed, we are
aware of many more inversions in the works right now. Letting
our corporate tax base erode through inversions will worsen our
fiscal challenges over the coming years and will reward
countries that practice race-to-the-bottom tax competition in
an effort to lure away our large U.S. multinationals.
As the Secretary indicated in his June 15 letter, Congress
should pass anti-inversion legislation immediately with an
effective date of May 2014.
Thank you for the opportunity to speak to you today. I look
forward to answering your questions.
The Chairman. Thank you very much, Mr. Stack. That is very
helpful.
[The prepared statement of Mr. Stack appears in the
appendix.]
The Chairman. Our next witness will be Mr. Pascal Saint-
Amans. We welcome you.
STATEMENT OF PASCAL SAINT-AMANS, DIRECTOR, CENTRE FOR TAX
POLICY AND ADMINISTRATION, ORGANISATION FOR ECONOMIC CO-
OPERATION AND DEVELOPMENT, PARIS, FRANCE
Mr. Saint-Amans. Thank you, Mr. Chairman. Chairman Wyden,
Ranking Member Hatch, distinguished members of the committee,
thank you for the opportunity to testify today here.
The OECD was founded in the aftermath of World War II under
the leadership of the United States. It is a country-driven
organization with 34 countries, the U.S. being the largest
member and playing a key role, and it works by consensus. It
does a lot of work on tax, and in the tax area we do consult
extensively.
On the project related to Base Erosion and Profit-Shifting,
we have consulted civil society, businesses, all stakeholders.
In this project, we have issued a number of discussion drafts.
More than 3,500 pages of comments have been received and have
been taken into account. We have conducted five public
consultations, as well as webcasts which have been looked at by
more than 10,000 viewers.
In the area of tax, the OECD facilitates cooperation in tax
administration between its member countries to eliminate double
taxation. As you know, taxation is at the core of countries'
sovereignty, and each country is free to set up its corporate
tax system the way it chooses, but, as a result, there are
risks of double taxation which are not conducive to cross-
border investment.
Since the 1920s, a common set of standards has been agreed
to, and the OECD has abated this work since the 1950s. In
particular, we have come up with a model tax convention and
transfer-pricing guidelines. These rules have worked well, but
they have also not kept pace with the economic changes and
globalization. As a result, they have been good at eliminating
double taxation, but they have also facilitated unintended
double non-taxation. This is an issue for most governments
across the world for many reasons.
Low taxation in itself is not a problem. On the contrary,
the OECD favors low corporate tax, low rates, and broad bases.
But this is an issue because, as long as countries decide to
have a corporate income tax, the corporate income tax needs to
be paid by all taxpayers. And there is a need now to, one, make
sure that the rules make sense. The current rules are no longer
adapted to globalization, and there is the gain through
artificial settings.
There is a divorce now between the location of the activity
and the location of the profits, which can be booked in a
jurisdiction where absolutely nothing is happening. As a
result, the sovereign right of countries is undermined. This is
a global issue; this is not an issue targeted to U.S.
companies. U.S. companies only account for less than a quarter
of the Fortune Global 500 companies. So it is a global issue
concerning U.S. and non-U.S. companies.
Second, there is a need to level the playing field. An
uneven playing field between companies is not conducive to the
right location of capital. Companies operating at the domestic
level are at a competitive disadvantage because they cannot use
the loopholes in the international tax framework.
Three, there is a need to reduce uncertainty. Uncertainty
is bad for companies, it is bad for the investment climate, and
there is increased uncertainty because these rules do not make
a lot of sense.
A number of tax administrations are trying to dispute the
position of companies that are legal. The tax administrations
are frustrated, and a number of countries are walking away from
the consensus, from the common interpretation of the rules, and
that results in uncoordinated unilateral measures to protect
their tax base, but that increases uncertainty. Therefore, we
need to address these serious risks for businesses.
The response from governments has taken place in the
context of the G-20, which has been called on to address the
issue of Base Erosion and Profit-Shifting. We have brought all
the G-20 and the OECD countries onto an equal footing to find
ways to address this issue of the tax framework by consensus in
2 years' time so that principles can be agreed upon quickly to
reduce the risk of uncertainty. We need a principled approach
and a cost-effective approach to limit the compliance burden
for companies and to reduce controversy.
This is not a revenue-grabbing exercise and should not be a
revenue-grabbing exercise, but a useful consensual exercise for
the common principles to be more accepted by ensuring
consistency in the cross-border environment, increasing
substance requirements, and promoting transparency. The
objectives are to secure the consensus and, therefore, reduce
uncertainty and improve the way we can solve disputes.
We have come up with an action plan of 15 measures which
are described in my written testimony. Some of them are about
neutralizing hybrid mismatches, reducing the abuse of tax
treaties, or improving transfer-pricing rules.
As a conclusion, I would say that the issue of Base Erosion
and Profit-Shifting is widely shared across countries, and,
here in the U.S. in particular, we are aware that you are
planning to address the U.S. tax system, and we hope that the
work we are doing at the international level, with your support
and the engagement of the U.S. Treasury, can be useful to
promote growth and jobs here in the U.S. by fixing some of the
issues of the U.S. tax system. The work of the OECD in that
context, we hope, is particularly timely, and we hope that it
will inform your debate.
We, of course, are fully available to respond to your
questions and further assist you.
The Chairman. Thank you, Mr. Saint-Amans.
[The prepared statement of Mr. Saint-Amans appears in the
appendix.]
The Chairman. Let us now go to Dr. Desai. Welcome.
STATEMENT OF MIHIR A. DESAI, Ph.D., MIZUHO FINANCIAL GROUP
PROFESSOR OF FINANCE, AND PROFESSOR OF LAW, HARVARD UNIVERSITY,
CAMBRIDGE, MA
Dr. Desai. Thank you. Chairman Wyden, Ranking Member Hatch,
and members of the committee, it is a pleasure to appear before
you today to discuss international tax reform. I am a professor
of finance at Harvard Business School and a professor of law at
Harvard Law School.
Recent merger transactions highlight long-simmering
problems in the U.S. corporate tax code, particularly with
respect to its international provisions. My comments attempt to
outline briefly the origins of these transactions, the range of
alternative solutions, guidelines for evaluating alternative
reforms, and some reforms that should be avoided.
The last 12 months have witnessed a remarkable wave of
merger transactions that facilitate the expatriation of U.S.
corporations. Such transactions reflect the effects of policies
and of the changing structure of multinational firms. From a
policy perspective, the transactions highlight the increasing
costs of employing a worldwide tax regime, when most other
large capital-exporting countries no longer maintain such
regimes, and a corporate tax rate that stands well above rates
employed by other OECD countries. From a firm point of view,
the transactions highlight the increased mobility of activity
in today's economy, the growing de-centering of firms whereby
headquarter locations have been split up and reallocated around
the world, and the growing importance of non-U.S. markets for
U.S. firms. Rather than questioning the loyalties of
executives, it is critical to understand these underlying
structural and secular forces.
While these transactions naturally attract growing
attention, inversions are merely the most visible manifestation
of these developments. In addition to inversions, these forces
are giving rise to incorporation decisions by entrepreneurs
that anticipate the burdens of being a U.S. corporation, merger
patterns that reflect the penalties of being domiciled in the
United States and the importance of offshore cash for U.S.
corporations, investment patterns by U.S. and foreign companies
and profit-shifting activities that are not value-creating, and
the consequent negative impact of all of these distortions on
the U.S. labor force.
While it is tempting to limit attention to the more
sensational effects and characterize them as tax-avoiding
paper-shuffling, this would effectively be missing the forest
for the trees. Reforms should be focused exclusively on
advancing U.S. welfare, with particular attention on reforms
that will improve American wages. These goals are mistakenly
thought to be achieved by limiting the foreign activities of
U.S. firms, as foreign activities can be viewed as diverting
economic activity away from the U.S.
In fact, the evidence suggests the opposite. As firms
expand globally, they also expand domestically. Indeed,
American welfare can be advanced by ensuring that investments
in the U.S. and abroad are owned by the most productive owner
and that American firms flourish abroad, a goal advanced by the
territorial regime that has now been adopted by most comparable
countries.
While the developments described above have crystallized
the case for international tax reform, with an increasing
attention on switching to a territorial regime, there is still
tremendous variation in proposals for territorial regimes. Some
proposals, including those with an alternative minimum tax on
foreign profits, are tantamount to a back-door worldwide regime
with even more complexity than today's system.
Revenue consideration should figure largely in tax reform
today, but should be accorded secondary status in this setting
given the very limited revenue provided by current
international tax rules and the remarkable complexity and
distortions required to secure any such revenue. Additionally,
it is not clear that policies should prioritize revenue
considerations in other countries.
More broadly, the corporate tax is ripe for reform. In
addition to international reforms and a rate reduction, reform
should address the two other major developments in the
corporate tax arena: the growing prominence of non-C corporate
business income and the disjunction between profits reported to
capital markets and to tax authorities.
A useful blueprint for reform would include moving to a
territorial regime, unencumbered by excessive complexity;
considerably lower rates in the range of 18 percent to 20
percent; better alignment of book and tax reporting of
corporate profits; and by some taxation of non-C corporation
business income. This combination of reforms has the potential
of addressing significant changes in the global economy in a
revenue-neutral way that will advance U.S. welfare. More
fundamental reforms, including those that replace the corporate
tax with a consumption tax are preferred, if feasible.
Legislation that is narrowly focused on preventing
inversions or specific transactions runs the risk of being
counterproductive. These transactions are nested in a broader
set of corporate decisions leading to several unintended
consequences.
For example, rules that increase the required size of a
foreign target to ensure the tax benefits of an inversion can
deter these transactions, but can also lead to more substantive
transactions. More substantive transactions are likely to
involve the loss of U.S. activity as American firms will be
paired with larger foreign acquirers that demand the relocation
of more activity abroad, including headquarters functions.
Similarly, specific regulations targeted at inverting firms may
also lead to foreign firms leading some transactions to avoid
those regulations.
While it is tempting to address specific transactions in
advance or in lieu of broader reform, it is useful to recall
that the last wave of anti-inversion legislation likely spurred
these more significant recent transactions and reduced the
prospect of reform in these intervening years.
Members of the committee, I admire your foresight in
addressing these issues. These highly visible manifestations of
the structural problems in the corporate tax provide a
significant opportunity for genuine reform.
I would be delighted to answer any questions.
The Chairman. Thank you very much, Professor.
[The prepared statement of Dr. Desai appears in the
appendix.]
The Chairman. We now welcome Dr. Peter Merrill and look
forward to your comments.
STATEMENT OF PETER R. MERRILL, Ph.D., DIRECTOR, NATIONAL
ECONOMICS AND STATISTICS GROUP, PRICEWATERHOUSECOOPERS,
WASHINGTON, DC
Dr. Merrill. Chairman Wyden, Ranking Member Hatch, members
of the committee, thank you for the opportunity to testify
today.
My name is Peter Merrill. I am a principal with
PricewaterhouseCoopers. I hold a Ph.D. in economics. The focus
of my practice is economic effects of tax policy. I am
appearing today on my own behalf. The views I express are my
own.
I have been asked to compare how the U.S. rules for tax on
international income compare with the rules of other countries.
In my testimony, I will focus on two features of the U.S.
corporate tax system that fall far outside international norms:
the high corporate rate and the worldwide system of taxation.
These features of the U.S. tax system make it more difficult
for U.S. companies to compete in global markets.
U.S. multinationals face ever-growing competition from
abroad. Over the last 15 years, the number of U.S. companies in
the Forbes Global Top 500 list has dropped by a third from 200
to 135. Loss of global market share by U.S. companies is due to
a variety of factors. The out-of-step U.S. tax system is seen
by many as a hindrance rather than a help.
The top U.S. corporate statutory rate, including State tax,
is 39.1 percent. This is the highest rate among major
economies, more than 14 points above the average for the other
OECD countries, and almost 10 points higher than the average
for the other G-7 countries.
After the Tax Reform Act of 1986, the U.S. had a relatively
low corporate tax rate. However, since then, the other OECD
countries have reduced their rates by a collective average of
19 points, while the U.S. Federal corporate tax rate was
increased in 1993 to 35 percent, where it has remained since.
And, while it is widely recognized that our statutory corporate
tax rate is high, studies show our effective tax rate also is
high by international standards.
In addition, the U.S. has a worldwide system under which
foreign income earned by foreign subsidiaries of U.S. companies
is subject to U.S. tax when received by the U.S. parent. Unlike
the United States, all other G-7 countries and 28 of the other
33 OECD countries have adopted territorial tax systems.
As a result of these trends, U.S. multinationals
increasingly face foreign competitors that are taxed under
territorial systems. Within the OECD, 93 percent of the foreign
competitors on the Global Top 500 list were based in countries
that use territorial tax structures. The significance of this
is that foreign competitors of U.S. multinationals can invest
their foreign profits at home without an added home country
tax.
Turning to recent reforms, in 2009, three OECD countries
adopted territorial tax systems: the U.K., Japan, and New
Zealand. The U.K. adoption of a territorial system was the
first step in a multiyear reform package which also included
lowering the corporate income tax rate from 28 percent to 21,
with a further reduction to 20 percent scheduled next year.
The British government articulated the rationale for these
reforms as follows, quote: ``The government wants to send out
the signal loud and clear that Britain is open for business. In
recent years, too many businesses have left the U.K. amid
concerns about tax competitiveness. It's time to reverse this
trend. That is why the government is prioritizing corporate tax
reform.''
Japan's adoption of a 95-percent dividend exemption system
had been advocated by the Ministry of Economy, Trade, and
Industry to encourage a repatriation of foreign earnings. In
addition, since 2012, Japan's combined corporate tax rate has
been cut 5 points to 35.6 percent, and Prime Minister Abe's
cabinet has recently approved a phased reduction to below 30
percent.
Also in 2009, New Zealand switched back to a territorial
tax system after a 21-year period in which it had operated
under a worldwide system without deferral, thereby bringing New
Zealand's tax system back in alignment with international
norms.
In closing, the combination of our high corporate rate and
worldwide system creates an incentive for U.S. multinationals
to reinvest foreign earnings outside the United States.
According to a recent study co-authored by Laura D'Andrea
Tyson, former chair of President Clinton's Council of Economic
Advisers, switching to a territorial system, even without
reducing the U.S. tax rate, would, on an ongoing basis,
increase annual repatriations by over $100 billion a year and
create 150,000 new jobs per year.
Reforming the U.S. system to align with international norms
would enhance the ability of U.S. companies to compete abroad
and create jobs at home.
Thank you, and I would be happy to answer questions.
The Chairman. Dr. Merrill, thank you very much.
[The prepared statement of Dr. Merrill appears in the
appendix.]
The Chairman. Dr. Robinson?
STATEMENT OF LESLIE ROBINSON, Ph.D., ASSOCIATE PROFESSOR OF
BUSINESS ADMINISTRATION, TUCK SCHOOL OF BUSINESS, DARTMOUTH
COLLEGE, HANOVER, NH
Dr. Robinson. Chairman Wyden, Ranking Member Hatch, and
distinguished members of the committee, it is an honor to
appear today to testify on the important topic of international
corporate taxation.
I am an associate professor at the Tuck School of Business
at Dartmouth College. I teach financial accounting and
taxation, and my research centers on multinational
corporations.
It is clear that reform is needed. The international system
is one of the most technically complex areas of the U.S. tax
code, but raises little revenue. My testimony summarizes, in my
view, what the academic literatures in economics, finance, and
accounting collectively offer in terms of evaluating the range
of alternative solutions.
The top U.S. Federal corporate income tax rate is 35
percent. This is the highest rate of all OECD countries and far
exceeds the 23.5-percent average.
Proponents of adopting a territorial system in the U.S.
often cite competitiveness issues. A common assertion is that
U.S. firms are at a competitive disadvantage because they face
larger tax burdens operating under a worldwide system than
their competitors operating under territorial systems.
Generally speaking, this is because U.S. firms face a high home
country tax on foreign profits, whereas their competitors face
no home country tax on foreign profits.
Yet, no country operates either a pure worldwide or a pure
territorial system. When loopholes exist that facilitate the
indefinite deferral of the home country tax on foreign profits
under a worldwide system, the pendulum swings back to a pure
territorial system. Likewise, as eligibility for the foreign
dividend exemption under a territorial system is appropriately
restricted, the pendulum swings back to a pure worldwide
system. This means it is possible for a well-designed
territorial system to be at least as, if not more, burdensome
than the poorly designed U.S. worldwide system that we have
today.
Evidence suggests that U.S. firms are adept at indefinite
deferral. One study finds that financially unconstrained U.S.
firms shift as much income as firms operating under territorial
systems. Also, there is no evidence that the global tax burden
of a firm depends on how foreign profits are taxed in the home
country of its parent.
There is some evidence that certain location decisions
differentially impact firms' global tax burdens depending on
the home country. For example, a firm resident in home country
X realizes a larger reduction in its global tax burden by
operating in source country A than a firm resident in home
country Y, also operating in source country A, whereas the
opposite may be true for these two firms when operating in
source country B. This suggests that the burden of an
international tax system depends significantly on anti-abuse
provisions that selectively narrow or broaden the tax base with
respect to certain types of income earned in specific locations
rather than whether the tax system is worldwide versus
territorial.
Similarly, other research shows that decisions about
headquarter relocations, tax haven operations, and ownership
structures depend on the existence and strength of anti-abuse
legislation. Maintaining our current worldwide system with
deferral, or introducing a territorial system, leaves the need
for anti-abuse provisions that are difficult to administer and
enforce.
Another consideration is eliminating implicit costs.
Avoiding repatriation, which triggers the home country tax on
foreign profits under our current system, prompts firms to
allocate economic resources in an inefficient manner. Examples
include making value-decreasing foreign acquisitions or the
inability to respond to domestic investment opportunities.
Maintaining a worldwide system but eliminating deferral would
greatly reduce these costs. Adopting a territorial system may
not.
Firms operating under territorial systems face implicit
costs when attempting to circumvent anti-abuse legislation,
which serves as a backstop that otherwise imposes a home
country tax on foreign profits that have not been subject to a
robust tax system abroad. To my knowledge, there is no estimate
of these costs, but my expectation is that they would be
greater than under a worldwide system without deferral.
My overall assessment is that our international tax system
can be adequately reformed. We need not entirely abandon our
current system in favor of a fundamentally different system.
Limiting deferral and lowering the statutory rate would
generally reduce incentives to shift income, eliminate the
implicit costs of avoiding repatriation, and reduce complexity
and uncertainty for firms.
Thank you, and I would be happy to answer any questions.
The Chairman. Dr. Robinson, thank you.
[The prepared statement of Dr. Robinson appears in the
appendix.]
The Chairman. Our final witness is Mr. Allan Sloan.
STATEMENT OF ALLAN SLOAN, SENIOR EDITOR AT LARGE, FORTUNE
MAGAZINE, NEW YORK, NY
Mr. Sloan. Chairman Wyden, Ranking Member Hatch, members of
the committee, I am flattered to be here, and I am honored and
especially pleased to be hitting cleanup, which is my normal
role in journalism.
Before I proceed, I have to say that I am speaking for
myself alone. I am not speaking for Fortune magazine, my
employer. I am not speaking for Fortune's owner, Time, Inc. I
am not speaking for the Washington Post, which has run my
material for more than 20 years.
I, like Senator Hatch, am appalled to see that inversions
are becoming a partisan wedge issue. I do not like this. Now,
at Fortune several weeks ago, we put an American flag on the
cover. We called inversion positively un-American, but we were
not being partisan. We were being Americans.
Fortune is divided between Republicans and Democrats. We
are acting collectively, not in the social sense, but in the
societal sense. This is not a Republican problem. It is not a
Democratic problem. It is a problem for everybody. It is for
all of us. And, if you do not stop inversions now with some
sort of band-aid, by the time you get around to doing it, there
will be tens of billions of dollars of taxes that will have
been lost and will never be recovered.
Now, I have been writing about inversions and researching
them for months, and I have heard the argument that, well,
inversions are a symptom; you cannot deal with them unless you
deal with the whole problem, and, if you deal with the whole
problem, you deal with inversions.
Well, I happen to have a daughter who is an emergency room
doctor, and, when someone shows up at the ER bleeding, the
first thing they do is they put on a tourniquet, they stabilize
the patient, and then they try to deal with the underlying
problem. They do not say, ``Well, gee, we have to deal with the
underlying problem first.''
You have an emergency here. It may not seem that way, but
you have the beginning of, I think, a massive flood of
inversions unless you stop this. Now, I know very little about
tax, I know very little about law, but I do know something
about Wall Street and manias. And I look at this, this
inversion thing, and it reminds me of the dot-com bubble, where
people did things that were just crazy, but everyone was doing
them. And all these people with degrees and a lot of money and
fancy suits were whispering in your ear, ``Well, you have to do
this,'' so people did it, and it was just a disaster.
I have written about Wall Street for large parts of my
career, and they gave us the Internet bubble, they gave us
toxic sub-prime securities, and now they are giving us
inversions. It is a product. It is the latest thing that is
good for Wall Street.
There is this whole rationale that surrounds it, but I do
not think it is good for society. It just does not work. And I
do not pretend to understand anything about the international
tax system, except that I do not understand it. I am a simple
person; I am a recovering English major; I am not a legal
person. I mean, if I were you--which will probably never
happen, because you have to be nice to people, and I do not do
that well--I would adopt one of the Levin bills. And Sandy
Levin will probably be angry with me, but I would adopt the
Carl Levin version, the one that has an expiration in it,
because, if you can just stop these things for a while, you can
buy time to fix the system. If you sit around and say, ``Well,
in a few years we will do this, it will all be fine,'' by then,
the patient will have lost so much blood, it is going to be
very, very hard to do anything remotely revenue-neutral in a
tax reform.
The other complaint, again, I have heard endlessly is, oh,
it is so unfair to make this May 8th, which is the date in the
Levin transaction, which also, I believe, happens to be the
date that Senator Wyden published his op-ed in the Wall Street
Journal, which messed me up because he wrote what I was going
to write. So I was furious, but I came here anyway. [Laughter.]
So the May 8th deadline was known. If you look at the
contracts of some of these deals, there are provisions in there
in case the anti-inversion stuff changes. So it is not as if
this is unprecedented or unfair. I mean, everybody knows this.
You changed the rules retroactively in 2004, and, as best I
could tell, there were no earthquakes or brimstone or fire from
the sky.
So, please, if you can act like Americans, which I know you
can, instead of squabbling, and you get the Senate to go along
and deal with the House, we can put on the tourniquet, we can
stop the patient from bleeding out, then we can fix the system,
and that is what I hope you will do.
Thank you for your time. I am happy to answer any
questions.
The Chairman. Mr. Sloan, thank you.
[The prepared statement of Mr. Sloan appears in the
appendix.]
The Chairman. Colleagues, we will stick to 5 minute rounds,
and we will get as many members in as we can.
I am going to ask one question of all of you. I am going to
start with you, Mr. Stack.
I have been about as big a flag-waver for comprehensive tax
reform as anybody around here, and I am going to continue to
keep pushing for bipartisan tax reform as aggressively as
possible. The reality is, nobody believes that you can get
comprehensive tax reform passed this year. And, with the
investment bankers in that inversion feeding frenzy, there may
be 25 more inversions during that time.
So I am just going to go down the row here this morning and
ask each of you: will that be a bad thing for America?
Mr. Stack?
Mr. Stack. Yes, Senator. That is a bad thing for America.
That money is not just a one-time hit. That is a hit we take
the year a company inverts, and it is a cost we incur
throughout the 10 years of a budget window.
In addition, I just want to add, companies not only reduce
their U.S. tax bill on day 1 when they invert, but they also
adopt techniques to keep stripping out of the U.S. for each of
the next 10 years as well. So we get hit with a double-whammy.
It has a long-term effect. It is permanent. And so the cost of
waiting, I think, is very high.
The Chairman. Mr. Saint-Amans?
Mr. Saint-Amans. I also think it is bad. It is a symptom
of, indeed, a disease. Either you trap cash growth, which
compels these companies to reinvest in the U.S.--and I think
that is one of the challenges of the U.S. tax code today--or
the result is inversions, meaning that you lose the control of
these companies which invert in another country, and that is a
loss for the U.S.
So overall it is bad, and it is a symptom of an issue in
the tax code.
The Chairman. Dr. Desai?
Dr. Desai. I think in the short run, it will feel good to
do something. I think in the long run, it is not clear whether
it will help the country, and I think the reason for that is it
will have all these unintended consequences.
I think there are a lot of medical analogies that are being
thrown around today, which I think are helpful. Rather than a
tourniquet, we might have a bleeding patient, and these things
might just anesthetize the patient.
The Chairman. So I think I am going to take that as a
``no.''
Dr. Merrill?
Dr. Merrill. On this one, I very much agree with the
comments of Pascal, which is that these transactions are a
symptom of a very broken system.
Certainly I can understand the desire to put on the
tourniquet, but, if you leave it on too long without resolving
the underlying problem, you get gangrene. So I can understand
the desire to do something in the short term, but there is the
risk of unintended consequences. So fixing the system is
ultimately the only real answer to stop the problem.
The Chairman. So you are in the middle of all this. We will
put you down in that way.
My concern about that position, for both of you, is that
tax reform is moving slowly, but inversions are moving rapidly.
And that is a prescription for chaos, and that is why I want to
see us address both of the issues in a bipartisan way.
Dr. Robinson?
Dr. Robinson. I do not have any data on this, but I do
remember reading about inversions, companies leaving other
countries, such as the U.K., and then, when the tax system is
reformed, they have come back again. So I do not have any data
on that, but my sense is that these companies may not be lost
forever.
I also think, as far as I understand inversion
transactions, it only affects the tax on the future income. It
does not impact the tax on the accumulated earnings. So, in
that respect, I do not think we run the risk of waiting to
solve the real problem and sort of letting the markets play out
as they do.
The Chairman. You think it would be a bad thing.
Mr. Sloan?
Mr. Sloan. I think letting 25 companies invert and then
fixing the tax code is a recipe for disaster. I know a little
bit about how inversion works, and Mr. Stack is absolutely
right that the problem is not so much what happens to foreign
profits, but that it becomes much, much easier to move money,
to earnings-strip out of the United States, and you have to
stop this.
And, at some point when we are not on the clock, I will
bandy medical analogies with my colleagues, but this is not the
time. So I will just let that go, and we will deal with that
later.
The Chairman. Let me see if I can get one other question
in, and I will make this for you, Dr. Desai, given what you
said.
Let us take Walgreen's. Walgreen's is an American icon. It
is located in the heart of our country, and they are talking
about inverting right now.
Should Americans be concerned about the prospect that, if
Walgreen's inverts, they will strip profits out of the United
States and put them into tax havens? Is that something
Americans ought to be concerned about?
Dr. Desai. Without question, absolutely. There is no
question about that. The secondary question is, what we do
about it, but absolutely we should be concerned about that.
The Chairman. Very good.
Senator Hatch?
Senator Hatch. Thank you, Mr. Chairman.
This question is for Dr. Robinson and Dr. Merrill.
Dr. Robinson, in your written testimony, you write that,
quote, ``There is no evidence to support the assertion that
U.S. multinational corporations are at a competitive
disadvantage because they face larger corporate tax burdens
than their competitors under a worldwide rather than
territorial tax system.'' You then cite three studies in
support of your statement, including one study that finds that
U.S. multinationals have effective tax rates that are 4 percent
lower than multinationals based in the European Union. But are
there not studies that show that U.S. multinationals are
subject to higher effective tax rates than foreign-based
multinationals? That seems to indicate that the U.S.--well, let
me put it this way.
Let me give you an example. Dr. Merrill cites numerous
studies showing that in his written testimony. The
Congressional Research Service released a report earlier this
year studying effective tax rates. In one part of the report,
CRS notes that the effective corporate tax rate in the United
States is 27.1 percent as compared to the rest of the OECD
countries that have an unweighted average of 23.3 percent.
Now, that seems to indicate that the U.S. corporate
effective tax rate is almost 4 percentage points higher, not
lower, than the other OECD countries, at least by one measure.
Now, would you please comment on this?
I would also like Dr. Merrill to comment on the effective
tax rates faced by U.S. multinationals as compared to foreign-
based multinationals.
Dr. Robinson. Right. So the studies that I quote in my
written testimony measure accounting effective tax rates from
firms' financial statements. So I am not sure what Dr. Merrill
is going to follow up with in terms of his study. It may be a
difference in how tax rates are measured.
But in the accounting literature, there have been a number
of studies, published and unpublished, that have searched
extensively for differences in the accounting effective tax
rates of firms resident in worldwide versus territorial
countries that also looked at, as I mentioned, the effect on
these effective tax rates of specific location decisions. And
there is not, at least to my knowledge, in the accounting
literature, as measured by an accounting effective tax rate,
any evidence to suggest that U.S. firms have higher rates.
Senator Hatch. Dr. Merrill?
Dr. Merrill. In my written statement, there is a comparison
of six different studies that compare effective tax rates of
U.S. and foreign companies. None of the studies is specifically
focused on the foreign income of multinational companies, and
perhaps this is what Dr. Robinson's comment is referring to.
The studies I refer to look at U.S. versus foreign
companies, including accounting data. One of the studies was
published by the Business Roundtable. It compares the financial
statement accounting tax rate of companies in 58 different
countries. The U.S. had a higher than average book effective
tax rate than the other multinationals in that study.
The World Bank does a study. We help them with that. It
compares taxes in 183 countries, looking at purely domestic
companies. And there are several other studies that I have
cited that had a focus primarily on domestic investment. And so
there are a range of studies.
I must say that, looking at a broad range of studies,
almost every study I have seen has shown that, when you do an
international comparison of the U.S. effective tax rates versus
foreign, whether it is from financial statements, whether it is
done through marginal or average effective tax rates,
accounting studies, the U.S. consistently comes up above
average.
So I put that in my testimony, because it is commonly
thought that effective tax rates of U.S. companies are low, but
by international standards, according to all the studies I have
seen, except for actually the ones in Leslie's testimony, the
U.S. comes up in the top quartile.
Senator Hatch. Thank you.
Do I have time to ask one more?
The Chairman. Yes, of course.
Senator Hatch. This question is for Dr. Desai. It seems
that a discussion of international tax reform can at times
result in a debate of capital export neutrality versus capital
import neutrality.
Such a discussion usually is not helpful, in my opinion,
and typically ends up going nowhere. But you have developed an
interesting new theory of international taxation--capital
ownership neutrality--the idea being that a tax system should
not distort the ownership of assets. And, in fact, capital
ownership neutrality seems to fit in nicely with the
acquisition inversions that we are seeing today in which a U.S.
corporation acquires a smaller foreign corporation and inverts
as part of the acquisition.
Now, my question is this. If a U.S. corporation wants to
acquire a foreign corporation, it seems that the U.S.
corporation is at a disadvantage if it is competing against a
foreign corporation based in a country with a territorial-type
tax system. As we know, most developed countries have adopted
territorial types of tax systems. In fact, 28 of the 34 OECD
countries have territorial-type tax systems.
Is it accurate that the U.S. corporation is at a
disadvantage?
The Chairman. Doctor, if you could, please give us a brief
answer, because I want to recognize Senator Grassley.
Dr. Desai. Absolutely. So, yes. Along with Jim Hines, I
developed capital ownership neutrality, and the central idea is
what you said, which is, what matters is not where the dollars
go, but who owns what. And, in the context that we are talking
about, it is clear these inversions are manifestations of the
fact that U.S. firms are not good owners because of tax
provisions of assets around the world, and it is better to be
domiciled somewhere else.
So I think it is a clear manifestation of the patterns that
give rise to why territoriality makes sense.
The Chairman. Thank you very much.
Senator Grassley?
Senator Grassley. Mr. Chairman, here is what I would like
to do with my time, my 5 minutes. I would like to ask Mr. Stack
a question to begin with, let him think about it for 4\1/2\
minutes, and I want to read a statement and then stop so he can
answer my question. [Laughter.]
The Chairman. Colleagues, at this point, we have had a vote
called, and I think it is the consensus of the members that we
will have to break, since there are three. So we will get as
far as we possibly can.
Senator Grassley?
Senator Grassley. Mr. Stack, this is the question I would
like to have you think about. Treasury recently informed me
that it has finally begun work on a report mandated by the
American Job Creation Act to study the 2004 anti-inversion
provisions. When does the Treasury Department expect to finish
its study of the 2004 inversions legislation? And before
enacting such important legislation, should not Treasury at
least complete the report mandated to study the issue?
Like most of my colleagues here today, I have deep concerns
about the practice of companies moving overseas for the primary
purpose of avoiding U.S. taxes. Average Americans and companies
that remain in America are rightfully outraged when companies
leave the United States, leaving the rest of us to foot the
bill. That is why, in the early 2000s, I led an effort to
prevent companies from simply setting up a filing cabinet and a
mailbox overseas to escape millions of dollars of Federal
taxes.
In 2004, when I was chairman, I was successful in enacting
for the first time reforms that established rules governing
inversions. Under these reforms, an inverted company continues
to be treated as a domestic company until there is a
significant change in ownership or substantive business
activities are located in the foreign country. A second feature
of these reforms prevents an inverted company from skipping
town without first paying taxes on untaxed earnings.
Prior to these changes, all the company had to do was move
its tax home out of the United States and file papers with a
tax haven. There were no rules or standards for determining
whether a transaction had substance or was purely a tax
avoidance scheme. A number of companies took advantage of the
lack of rules and standards to move to the Cayman Islands or
Bermuda, as examples. These inversions were purely on paper,
with no substantive change of current operation.
The 2004 provisions have successfully curtailed abuses
targeted by the legislation. As the nonpartisan Congressional
Research Service has said, these reforms, quote, ``effectively
ended shifts to tax havens where no real business activity took
place.''
Now, this is not to say that inversions no longer take
place. The 2004 reforms were never intended to establish a
Berlin Wall that forever trapped companies in the United States
regardless of business needs. These reforms were targeted at
and put an end to egregious abuses epitomized by Ugland House,
which serves as mailbox headquarters for thousands of
corporations. The inversions currently in the news mainly
involve a large U.S. multinational merging with a significant,
though smaller, foreign company, usually European. These are
not the traditional tax haven countries with little or no
corporate tax, but major U.S. trading partners with competitive
tax systems and rates.
There is little question that lowering one's tax bill
continues to be a factor in companies deciding to invert.
However, unlike transactions in the early 2000s, these are
substantive transactions that come with both risks and benefits
for companies involved. As a result, factors other than taxes
likely play a role in deciding to invert.
I do not condone that behavior. One area that should be
studied further is the role that tax rules that allow inverted
companies to strip income out of the U.S. play in a company's
decision to invert.
I am going to stop and ask Mr. Stack to answer my question
on the study that we asked for.
Mr. Stack. Sure. Senator, as we mentioned in our letter to
you of last week, now that we have gotten great guidance out in
various areas of inversions, we are working on the study.
I apologize. I cannot give a specific time frame for
completing it, but I would say that, given the pace of
inversions which has picked up recently, we would not think
there would be a need to await the study to bring back our full
attention to this issue which is happening before our eyes.
Senator Grassley. Thank you, Mr. Chairman.
The Chairman. Thank you, Senator Grassley.
Senator Brown?
Senator Brown. Thank you, Mr. Chairman.
I want to talk for a moment--and this is a question for
you, Mr. Stack--about earnings stripping.
Companies are using inter-company debt to lever up their
U.S. subsidiary and deduct interest of up to 50 percent of free
tax earnings, as you know, shifting profits to the lower-tax
country. The second element of this tax arbitrage is shifting
intellectual property and the attributed profits to tax havens.
My question is, what do we do right now to create a kind of
temporary tripwire that will allow legitimate mergers, but
prevent those arbitrage-driven inversions?
Mr. Stack. Thank you, Senator. One of the reasons we
singled out these kind of anti-stripping proposals in our
budget was because, even without reform, these things are going
on now, and they are going on particularly in cases where we
have inversions.
So, whether it be interest stripping, making it harder to
take intangibles out of the United States, or changing the
treatment of instruments that you can take a deduction on here
and have a no-income inclusion somewhere else, we think these
are all urgent needs that would protect our base even before we
do tax reform and will also protect our base while the
inversion wave is happening, and they are very important.
Senator Brown. Mr. Chairman, I want to ask a question of
Mr. Sloan. I also want to make one comment.
The more we read about this--and I appreciate that the
chairman has brought this out, I think, more effectively than
anybody in the Senate. People in this country increasingly
think the system is rigged. People in this country increasingly
see large companies find ways of avoiding taxes. People
struggle to pay their own taxes. People see these large
companies having benefitted from a manufacturing tax credit, an
R&D tax credit infrastructure in our country, using legal
means--nobody is arguing, most of us are not arguing they are
not using legal means--to find a way to avoid taxes.
I think this committee needs to take this charge very
seriously that the public increasingly is losing confidence in
this tax system, causing others perhaps to cheat, and
increasingly is losing confidence in this whole legislative
body's ability to do anything. And, if we cannot narrowly
follow Mr. Stack's advice and Senator Wyden's ideas and do
something narrowly now about inversions, we clearly have not
lived up to our public charge.
Let me ask a question of Mr. Sloan.
We are seeing increasingly more and more stories, partly
from Senator Levin's work on his subcommittee, that hedge funds
and investment banks are big drivers of these deals, which
indicates a potentially short-term focus on stock prices and
fees. The rewards to Wall Street are plentiful, as Mr. Sloan
said. Premiums are offered to shareholders of foreign companies
so the inverting companies may avoid U.S. taxes.
If you would, answer these couple of questions, if you
would, Mr. Sloan. What role, in your mind, do equity funds,
private equity funds, investment banks, hedge funds, play in
encouraging companies to avoid taxes by completing an
inversion? Is there any counterweight to this pressure that
companies receive from short-term-focused investors?
Mr. Sloan. All of these players are in business to make
money. They are in a competitive business. They want to show a
higher rate of return than other people so they can continue to
attract more money and get more fees. And, as long as something
is not illegal, they will do it.
If you talk with them socially, they are not bad people.
They are human beings, even like Senators or journalists. They
are regular people, but they have these forces that drive them.
And I think there are perfectly fine corporate CEOs who, if you
people will just protect them and get rid of the inversion
temptation, will be very happy not to invert.
But everyone now feels pressure, and everyone is scared,
and it is becoming a mania such that, by the time it fades
away, it will be too late.
Senator Brown. Thank you, Mr. Chairman.
The Chairman. Thank you, Senator Brown.
Senator Schumer is next. And I am going to try, even after
the first vote, to run over and vote, because we have
colleagues who feel very strongly about this.
Senator Schumer?
Senator Schumer. Thank you, Mr. Chairman. I want to thank
you and Ranking Member Hatch for holding this hearing today.
It is absolutely critical we quickly develop and process a
proposal to combat this growing trend by some U.S. corporations
to leave our borders for tax-avoidance purposes. There has been
a significant uptick in the number of inversions over the past
10 years. Forty-seven U.S. corporations have reincorporated
overseas through these inversions during that period. Now there
are more than a dozen prospective deals.
Many of my colleagues, particularly on the other side of
the aisle, argue we should not be looking at this issue in a
vacuum right now. They say we should instead be focused on
corporate tax reform. I would ask those arguing that we wait
for tax reform, just how soon do you think that is going to be
possible? Chairman Camp tried tax reform on the Republican
side. Even Speaker Boehner did not give it much credence.
So, if we wait for tax reform, we are going to have lots
more inversions, and it is going to take far too long, if we
ever get to tax reform at all. Saying that we should wait for
tax reform to deal with inversions is a green light to allow
many more inversions to occur. For some who make that argument,
frankly, it is an excuse to keep this loophole in place for the
foreseeable future.
The tax reductions achieved through inversions, as you
know, happen in a couple of different ways, Mr. Chairman.
First, by moving their domicile offshore, these companies are
no longer subject to U.S. taxes on any of their international
operations, and this has been appealing to types of businesses
that operate in a global supply chain, like pharmaceutical
companies.
But today we are seeing an uptick in more traditional
brick-and-mortar companies--Walgreen's, for instance--doing the
same thing. Why is that? Well, it is the second piece of the
inverter's tax-
avoidance equation. Not only can these companies avoid paying
taxes on their international operations when they invert and
reincorporate abroad, they can also avoid paying U.S. taxes on
their businesses that remain in the United States. One way they
do this is through a mechanism in the tax code called the
interest expense deduction.
It is a 5-step process. They set up a U.S. subsidiary to
operate their U.S. business. When that subsidiary owes U.S.
taxes, they transfer the corporate funds between the foreign
parent and the subsidiary and call it a loan to the subsidiary.
That loan triggers a U.S. tax deduction, the interest expense
deduction for the subsidiary, which then largely offsets their
U.S. tax liability. The loan is repaid through the profits of
the U.S.-taxed subsidiary to the foreign parent, and U.S. taxes
have been avoided. As a result, they pay little or no tax on
their U.S. profits as well.
Now, we have attempted to limit this type of behavior in
the past. We put a cap on the debt-to-equity ratio of the U.S.
subsidiary, but the current law still provides a very lucrative
tax benefit for inter-company benefit. In fact, Mr. Sloan, your
magazine or your website did an op-ed on this, talking about
the risks and rewards of inversions, which mentions the
interest expense deduction.
So, as we work together to put forward a proposal to combat
this growing challenge, we have to look at it from every angle.
Now, I support the proposal that Senator Levin and the
administration have been working on, which calls for an
immediate 2-year moratorium and increasing the number of
foreign shareholders to implement inversion from 20 to 50,
making it more difficult for it to happen. I do have concerns
with the management and control part of the Levin proposal,
because we want to keep jobs here at home, and the management
and control proposal may encourage jobs to grow abroad.
But Levin's proposal is not enough. We have to go further.
We should also include a proposal that further limits or
disallows the interest expense deduction to deal with the U.S.
profits that they are also trying to avoid. Doing so will be a
deterrent for those considering an inversion, as they will no
longer see that opportunity to avoid U.S. taxation, and it will
deal with the retroactive problem because you eliminate it
prospectively, but any company that did an inversion 6 months
ago, 1 year ago, 5 years ago, will still lose this deduction.
So it is a prospective policy action to counter past and
future inversion activity. It would ensure we do not leave
those inverters who are at the front of the line, the ones who
started the trend, with a competitive advantage.
So, Mr. Stack, my only question is--because my time is
running out, and I know my dear colleague is waiting--does the
administration agree that we should consider measures to
further limit or disallow the current interest expense
deduction for inverters in any legislative package we pursue to
combat inversions this year?
Mr. Stack. Yes, Senator. We fully agree, and we think you
have shone a light on a very dangerous part of the inversion
craze, which is the ability, the day after the inversion
transaction, to continue to strip the U.S. tax base. We have a
budget proposal to that effect, but we think you are pointing
to a very critical aspect of the inversion problem.
Senator Schumer. Thank you. I just want to say to companies
doing inversions, if you want to operate here, you want access
to this market, you want access to the workforce, access to the
economy, understand this here today. To continue to have that
access, you are going to have to pay your fair share of U.S.
taxes. Things are changing.
The Chairman. Thank you, Senator Schumer.
The time for the vote has expired. We are going to go with
Senator Stabenow. Senator Toomey is next. I am going to try to
come back just as quickly as I can. Thanks.
Senator Stabenow?
Senator Stabenow [presiding]. Thank you. I wanted very much
to be here, even though we are going to have to go running out.
Thank you to each of you.
First, I want to say to my colleagues, we have a place to
start tomorrow, which is the Bring Jobs Home Act. I am very
pleased to be working with Senator Walsh on that. It takes a
simple first step on what needs to be a series of steps and
will simply say, if you want to move your plant, if you want to
move the company overseas, we are not paying for the move; we
are not going to allow you to write off your costs of moving
out of this country. And, if you want to come back, we will be
happy to let you write that off and give you an additional 20-
percent tax credit. But if you leave, you are on your own.
Now, we know that is not enough, because we have a lot of
folks who only leave on paper. And so they are not really
picking up the plant and leaving. But I will say, Mr. Sloan, I
could not agree with you more. This is not a partisan issue.
This is an American issue. I think the American public is going
to be watching very closely to see which companies that need
consumers are doing this, and I think these companies
underestimate the reaction of consumers and other businesses in
going forward.
I do think if we can move forward and overcome a
filibuster, get on the Bring Jobs Home Act, we could add Carl
Levin's bill. And I am with you, even though I serve with both
my dear colleagues, Sandy and Carl in Michigan, I think Carl's
approach of a 2-year effort to get us to tax reform is the
right way to go, and we could add that certainly to the Bring
Jobs Home Act, and I believe that we need to do that and we
need to get started on this.
I also think it is important--Dr. Merrill, you are right, I
mean, certainly, all of you, saying we need tax reform, we need
to do that, we know we need to do that. We know we are in a
global economy. We have to address this. But we also do know
that I do not know of any sector paying 35 percent, our
corporate rate.
The reality is, we have a lot of incentives for companies
to invert. We want incentives that relate to manufacturing or
R&D or other things. But when I look at the list, from medical
devices at 18.8 percent or financial services at 16.5 percent
or petroleum production at 11.3 percent or down to public-
private equity which is paying a 0.8-percent rate, there is a
large disparity and a number of issues that we need to address.
Here is what I want a comment on, and we have two issues:
corporate tax reform and the global economy. How do we address
these and incentivize making things and growing things in
America and innovating in America?
And then we have folks who just plain do not want to pay
their fair share yet benefit from America. So you have folks
doing inversions who do not want to breathe Beijing's air. They
want to breathe American air. They do not want the water of
third world countries. They want to be able to drink the water.
They do not want the rule of law of a lot of countries. I know
in Haiti, talking to our businesses, you pull up a cargo ship,
you cannot get the product off the ship without paying a whole
bunch of bribes.
So they want our rule of law; they want our innovation,
education, and infrastructure; they want to breathe the air and
drink the water; they just do not want to contribute. That does
not sound like the normal American values to me. What it does
is create a race to the bottom where we are not going to have
customers, and then we are really not going to have businesses
as we go forward from here.
So this is of deep concern to all of us.
I guess, Mr. Stack, I would just simply ask you, when we
look at competitiveness internationally, from your perspective,
certainly the rate is important, but we know even going to 28
percent, that means eliminating R&D tax credit section 199 for
small businesses, it means eliminating accelerated
depreciation, which is so critical in a State like mine with
manufacturing.
There has to be more to it than just tax grade in terms of
investing in America, and I would ask you, if we are going to
stay competitive internationally, make things and grow things
here, what are some of the other priorities of tax reform
besides just lowering the rate?
Mr. Stack. Thank you, Senator. First, on the rates, I would
also add the point that a lot of the discussion about rates
kind of ignores the fact that there will always be countries
with lower rates than ours where people may want to seek to go
and there is this tax competition going on.
In terms of other things we could be doing, the first thing
I would want to point out--and this also relates back to
rates--is our effective rates, as you were pointing out, vary
widely. So we do not really have a level playing field across
our industries. Number two, we do not really have a level
playing field with countries that can take IP and put it
offshore or have a broad enough market offshore to take
advantage of some of these international provisions.
So, in addition to lowering the rates, we think it is very
important to broaden the base for these taxes so that we can
create some equality, eliminate the winners and losers, so that
everybody has the advantage of this lower effective rate as we
go forward. And, as you also point out, maintaining incentives
for research and development so that we remain the premier
country in terms of this type of activity is also a critical
concern.
Senator Stabenow. Thank you.
I believe, at this moment, I have to get over to vote or I
am going to miss the vote.
Thank you very much. Are we in recess?
We are in recess subject to the call of the chair. Thank
you very much.
[Whereupon, at 11:11 a.m., the hearing was recessed,
reconvening at 11:46 a.m.]
The Chairman. I very much appreciate Senator Portman's
patience. He and I have talked often about tax reform, and I
look forward to working closely with him on these issues.
Senator Portman?
Senator Portman. Thank you, Mr. Chairman. I have had some
long conversations with you, and I appreciate your championing
tax reform, and I liked your first response to the inversion
proposals.
We have a little difference of opinion on tactics here,
because I do think this is an opportunity for us to encourage
solving the problem rather than dealing with the symptom, and
we have heard a lot of testimony today about what will happen
if we just go after this particular issue, and I know there is
some difference of opinion among the panelists about that.
I do not think there is any difference of opinion, I hope,
among the panelists about the fundamental problem. Mr. Stack
and I just spoke. I have spent a lot of time talking to
administration officials about this issue too.
The bottom line is that it is not advantageous to be an
American company. It makes more sense to be a foreign entity,
to be able to take advantage of a tax system where the great
majority of our competitors--93 percent of our foreign
competitors, as Peter Merrill told us today--have a territorial
system, have a lower rate. And it is a deadly combination to
have this high rate and to have a worldwide system.
I just do not think what we are talking about in terms of a
short-term fix is going to help. In fact, there is some good
testimony about how it could even hurt because, if you just
deal with inversions, you have some unintended, perhaps, but
negative consequences--demanding the location of even more jobs
overseas is what Dr. Desai talked about.
My big concern is foreign acquisitions. Recently we sat
down with a lot of U.S. companies to talk about this issue. In
fact, I have been doing this for the last few years, as some of
you know, and have worked on this in the Super Committee, and
we are just hearing over and over again the fact that already
foreign acquisitions are on the rise, even without this rule.
So, yes, we can put this rule in place, and then we could
limit the deductibility of interest, as one of my colleagues
said, and we can make it even harder to be an American company.
What will happen is, we will have more and more foreign
companies owning U.S. assets. Some of those will be takeovers.
Recently, a biopharmaceutical company came to see me, this
was last week. They were from the Boston area. And I asked them
about the acquisitions in the Boston area of bio-pharma
companies. Twenty-eight companies have been acquired in the
last several years, 17 of those 28 were acquired by foreign
entities. So you sort of put the hole in the dam here, and then
you are going to have a flood over here, and you are going to
have an even worse result--even more pressure on jobs leaving
this country.
So we talk a lot about revenue and income stripping and
earnings stripping, and I agree we need to have a tax code that
captures income in the most efficient way, but this is about
jobs. So my question, I guess, to Mr. Stack is, what is going
to happen if we continue to make it harder to be an American
company? Are we not going to see more, not just acquisitions,
but acquisitions of American assets?
These companies also tell me that, because foreign
companies have higher after-tax profits, it is more profitable
for them. They can pay a premium for our assets, in other words
for subsidiaries being sold, and you will see more of that. You
will see American companies shrinking and not being taken over
by foreign entities.
What is your answer to that?
Mr. Stack. Senator, I think with the tax code, as we look
out in terms of leveling this playing field, it is important
for us to take, as an opening step, that we will never be able
to offer, let us say, rates as low as countries that are trying
very hard through tax competition to lure companies overseas.
So there will often be some kind of a tax differential between
the United States and other countries that might, on the
margins, fuel some of that acquisition activity.
We have a lot of great things in this country, though, that
keep companies here and keep them competitive and keep them
doing very well. So I do agree then--and all the plans on tax
reform seek to lower the rate, and there is universal consensus
that our rate is too high and we should be bringing it down.
And when we bring it down, we will come closer to leveling the
playing field with those foreign acquirers.
Senator Portman. So I think this is not just an important
problem, I think it is an urgent problem, and I think you all
have sounded the alarm here. Again, we have differences on the
witness panel and on our panel as to how to address it, but it
seems to me, when you look at the history of our country, the
only time you see major tax reform is when the administration
takes the lead. Treasury has to be engaged and involved. I am a
former OMB director. OMB has to be involved in the numbers.
What is Treasury doing? Tell me what concrete steps are
being taken to address this, as was said today, emergency
situation? Is it just to plug the hole in the dam here, or are
you actually looking at, as the President has talked about over
the last couple of years, actually solving the underlying
problem, making American companies more competitive?
Mr. Stack. Senator, the President's framework in 2012
really was kind of a far-reaching move forward to think
differently about our international tax rules, and that is to
say that it was going to be able to bring down the rates,
broaden the base to deal with some of the differential
effective rates I mentioned earlier, but also, through the
foreign minimum tax, try to cut out some of the game-playing
that goes on by stripping into very low tax jurisdictions. We
think that that kind of set the tone for some of the work that
was done both in the Finance Committee and by Chairman Camp,
and we think that there is a very robust set of proposals on
the table right now.
In addition, for many of the things we are talking about
today in terms of base stripping, we put several detailed
proposals in our budget to get at this opportunity, once a
company inverts, to strip out of the U.S. tax base, which, as
everyone knows, provides a lot of juice for these transactions
since they can do better at reducing U.S. taxes once they are
offshore than they could before.
So we think we have shown leadership in our framework. We
think we have shown leadership in putting concrete proposals in
our budget, and I know the President and Secretary stand ready
to work with Congress on both sides of the aisle to push
through international tax reform.
Senator Portman. I would love to see a proposal, and I
would love to see that push. I do not know, maybe my colleagues
see more of it than I do. Again, I have had some great
conversations with individuals at the Treasury and in the
administration, including at the White House, but I just do not
see the push.
I hope we will use this unfortunate situation where we have
examples every week of another major inversion, another one
this past week--and it happened to be a pharmaceutical
company--to actually get us to the point where we are solving
the underlying problem.
If we make it worse by making it even less advantageous to
be a U.S. company, I really worry we will look back 5 years
from now and see a hollowed-out American corporate base and
wonder what happened. What happened is, we abdicated our
responsibility here in doing the thing that everybody on this
panel, I think, agrees we have to do, which is reform our code
to make it competitive.
I know my time is up, Mr. Chairman. I appreciate the
testimony today. I hope it results in some very specific action
by the administration and by the Congress.
The Chairman. Thank you, Senator Portman. I look forward to
working with you on these matters in a bipartisan way.
I would say to our guests, I have some additional
questions. Senator Hatch is on a very tight timeline, and so I
would like Senator Hatch to go first.
Senator Hatch. That is very gracious of you, Mr. Chairman,
and I appreciate it. It is a pleasure to work with you.
This question is for Dr. Merrill. As you know, both Japan
and the United Kingdom adopted territorial types of tax systems
in 2009, switching from a worldwide tax system with deferral.
These are two countries with large economies. Japan is the
third-largest economy in the world and the United Kingdom is
the sixth-largest economy in the world.
Can you tell me why Japan and the United Kingdom switched
from a worldwide with deferral system like the current United
States tax system to a territorial system, and, after 5 years
of experience with a territorial tax system, what have been the
results for both Japan and the United Kingdom?
Dr. Merrill. Yes. Thank you for the question. The United
Kingdom was experiencing a phenomenon not unlike what we are
experiencing now. They saw a number of large multinational
companies, some quite significant, that had actually moved
their legal headquarters out of the U.K., primarily to Ireland.
And that was of great concern to the government, so they
decided that it would be appropriate to adopt a more
competitive tax system along the lines of the quote in my oral
statement so that their tax system would be more welcoming to
multinational business.
One of the factors for the U.K. is they have many companies
there that earn only a small part of their total income,
worldwide income, in the U.K., and yet the U.K. had a tax
system like ours that was taxing the worldwide income of
companies that only earned a small amount of income in the U.K.
So, in order to become a more attractive location for
multinational companies, they went to the territorial-type tax
system, 100-percent exemption of foreign dividends, and they
made a number of other changes, as I indicated, lowering their
tax rate. They have also adopted a 10-
percent refundable research credit. They also adopted a 10-
percent, phased-in 10-percent tax rate on income from patents,
and they also modified their C rule.
So they have done a whole package of things mainly to make
it more attractive for multinational companies to be
headquartered in the U.K., and they have been successful. As
Dr. Robinson mentioned, some of the companies that left the
U.K. actually have moved their headquarters back to the U.K. in
response.
Japan is a different situation. Obviously, the Japanese
economy has not been attracting the kind of growth that they
have been looking for, and they saw Japanese multinationals,
like the U.S., facing a very high corporate tax rate, a
worldwide system, and money was not being repatriated to Japan.
The Ministry of Economy, Trade, and Industry wanted to see that
money come back for additional investment in Japan, and that is
why they made the change.
Senator Hatch. Thank you.
Mr. Saint-Amans, glad to have you here. This is a question
for you. I appreciated what you wrote in your testimony, that,
quote, ``The work of the OECD is done by consensus. That is,
measures cannot be adopted without the consensus of all member
countries.''
Now, presumably, consensus of all member countries means
that all member countries will consent to the work the OECD is
doing or else the OECD will not do that work or will not issue
such a report. Am I right on that?
Mr. Saint-Amans. Yes, Senator. A consensus means that a
report or soft rule, which is what we develop, is agreed when
no country around the table objects to it.
Senator Hatch. And in making sure you have the consensus of
the United States, please keep in mind our system of separation
of powers. Lawmaking capabilities primarily are vested with the
Congress. In obtaining the consent of the United States, it is
necessary to get the consent of the U.S. Congress. So we do
appreciate you being here for this Senate hearing.
Will you please assure me that you understand that to
obtain the consent of the United States for the OECD's work,
including for the BEPS project, that Congress must be kept
informed of the work, and, of course, that has to be working in
conjunction with the U.S. Treasury as well?
Mr. Saint-Amans. Senator, I do think that not only the
Secretary, of course, but all the OECD member countries are
fully aware of this. We are more than happy to engage with the
staff on the Hill for the Senate, but without impeding on what
Treasury is doing.
And I would like to add that most of the measures which are
completed in the project, fighting base erosion and profit-
shifting, are soft rules. These are a common interpretation of
standards, and so they do not require translation by
parliament, but information from all stakeholders and, in
particular, the Congress, is taken seriously by the OECD
secretariat--and I will not speak on behalf of it, but I think
also by Treasury.
Senator Hatch. Mr. Stack, let me just ask you the same
question. Please reassure me that the U.S. Treasury Department
will keep Congress informed, but not get ahead of the Congress
in the decision-making process and in negotiations with the
OECD regarding BEPS.
Mr. Stack. Yes, Senator. We fully intend to do that. I have
already been up to the Hill twice to meet with bipartisan
staffs, both houses, and I look forward to continuing that
throughout the process.
Senator Hatch. We appreciate your work in that regard.
Thank you for doing that.
I want to thank all of you for being here. I have to leave
because of other commitments, but this has been extremely
interesting, and I am going to read the transcript so I will
know exactly what you all say. I am going to hold you to it
too.
Thank you, Mr. Chairman.
The Chairman. He will, be on notice.
We are moving toward the end of the hearing. Senator
Portman may have additional questions. But let me give you my
sense of where we are.
I certainly am not interested in building any walls. I want
to close a loophole, and then I want to drain the swamp. I want
to fix this dysfunctional mess of a tax code so we have
incentives for creating red, white, and blue jobs, creating
jobs here in our country.
I know we are going to be calling on you all often in the
days ahead. I just have a couple of other questions about
issues that are pending.
Senator Thune, you are next. If I could just finish these
two questions, then we will go right to you.
The first deals with the implications of inversions on
health care costs in America and the implications for the
American consumer.
I was struck by comments made in the Wall Street Journal
recently by the CEO of Abbott, who said that he was concerned
about the higher prices that American consumers would have to
pay if proposed inversions like his company's did not go
through. And I am still trying to figure out how these savings
are going to be passed on to consumers and, of course, to
taxpayers who put up so much of the money that funds the
Medicare program.
I will ask all three of our professors: Dr. Desai, Dr.
Merrill, and Dr. Robinson. Explain to me how somehow these
costs, particularly medical costs, because so many of the
inversions thus far are medical, explain to me how or even if--
because you have done some scholarship on this, Dr. Desai--this
is going to benefit the American consumer and the Medicare
program in particular.
Let us start with you, Dr. Desai.
Dr. Desai. I think the broad way to think about this
problem is to understand that this question relates to the
broader question of the incidence of the corporate tax, who
pays the corporate tax, and there are really three sets of
folks who can pay.
So the first is customers, which is what you are referring
to via the health care system; the second is workers; and then,
the third is capital or shareholders. So whenever there is a
tax-saving move like an inversion, we can expect those benefits
to accrue to one of those three sets of people. Either workers
are going to get high wages, shareholders are going to get high
returns, or customers will get lower prices.
I think most of the consensus in the scholarship is that
when taxes change, they do not typically get transmitted to
product prices, because----
The Chairman. They do not typically get translated to
product prices, which would be the prices that Americans pay
for health care.
Dr. Desai. In this example, exactly right.
The Chairman. Very good. Thank you.
Dr. Desai. They typically get transmitted more likely to
wages and, to some degree, to shareholders.
The Chairman. Very good. Let me then--because Senator Thune
has just come back--bring you into this question, Dr. Merrill
and Dr. Robinson, and that is the impact of reform on the
deferral issue. Of course, one of the goals around which there
is bipartisan support for corporate tax reform is to simplify
the system. I think we all understand that the international
tax is inherently complicated.
My question is, wouldn't repealing deferral go a long way
toward corporate tax simplification by eliminating the
complicated system that exists today of tracking unused foreign
tax credits and the related earnings and profits? In effect,
income would be subject either to immediate taxation or exempt,
and the current foreign tax credits would be utilized against
current taxable income.
So answer the question, if you might. Would deferral
eliminate a very complicated feature of the tax system, and
would doing that as part of bipartisan comprehensive tax reform
make the system more simple and understandable?
Dr. Robinson?
Dr. Robinson. I do think, as I put in my written testimony,
that the implicit cost of the U.S. tax system is higher than
the explicit cost, and what I mean by that is that the cost
associated with actually avoiding repatriation or maintaining
deferral for long periods of time is what I believe makes our
tax system uncompetitive.
I do think that eliminating deferral so long as the rate,
of course, was lowered sufficiently would be what I would be in
favor of, and the reason that I say that is because the
alternative approach, of course, is to implement some sort of
territorial system. But I think those types of systems, if you
design them appropriately, would have to recognize instances
where earnings were not subject to robust tax systems abroad,
and then you have to introduce all sorts of exceptions and
exclusions and base-broadening provisions. And, by the time you
introduce those, you are sort of right back where you started.
So I am largely in favor of ending deferral and lowering
the rate if it means a simplification.
The Chairman. Dr. Merrill, unless you want to add anything,
I will recognize Senator Thune. Is there anything you wanted to
add?
Dr. Merrill. Why don't we take Senator Thune's question?
The Chairman. Very good. Senator Thune?
Senator Thune. Thank you, Mr. Chairman. I want to thank you
and Senator Hatch for holding this important hearing, and thank
you all for making time to share your expertise with us.
I suspect there are significant differences of opinion
about how to improve the U.S. tax code, differences of opinion
among members here in the Finance Committee and probably in the
Senate and the Congress, but I think that all of us agree that
we want American companies to be competitive. We want for them
to be able to compete and win in the global marketplace, and I
think, unfortunately, we ask them to do it with one hand tied
behind their back, because we actually make the rules that they
play by. And, when you make bad rules, you get bad outcomes.
And there are economic signals right now that are driving a lot
of the decision-making that our businesses are following.
So I think some of this inflammatory rhetoric and accusing
them of not being economic patriots is really not helpful, and
I would hope that we could focus on not just the symptoms, but
actually the cause for these problems, and that is, we have an
outdated, dysfunctional tax code, with the highest rate in the
developed world. And we are also one of only a few countries in
the world that continues to use a worldwide system, that has
not moved to a territorial system. I should not say in the
world, but certainly one of the few countries in the OECD.
So I just think that we need to focus on the problem here,
and the problem is the high rate. There was a time back in 1986
when the tax code was last reformed where our corporate tax
rate was 5 points lower than the average. Now, it is about 14
points higher than the OECD average. This is what you are going
to get when you have these kinds of rules. So we need to change
the rules. We need to reform the tax code.
So I guess it seems, to me at least, that the system is
basically the worst of all worlds, because we are asking our
businesses to compete in the foreign marketplace, and not only
do we have the highest corporate income tax rate among OECD
nations, we are also, as I said, one of the few nations that
has a worldwide system of taxing income.
So, Dr. Merrill, I guess I would ask you, could you
elaborate a little bit on your testimony in terms of what this
means for a U.S.-based company competing in foreign markets
against companies that are based in nations with more modern
and favorable tax systems?
Dr. Merrill. Yes. Thank you. What we are seeing is a world
where a U.S. company that operates abroad is now generally
competing with foreign competitors in the same market, but
facing a very different home country tax system. They all face
the same rules in the country where they are operating.
The difference is, they face different home country
taxation. So, if the U.S. company earns income abroad and
wishes to invest it back home in the United States, bricks and
mortar, it wants to use the money to give back to its
shareholders, it wants to use the money to pay higher wages to
its workers, it faces a U.S. tax on that repatriated earnings
that would not be the case if it was a
foreign-headquartered company under a territorial-type system.
So we see this manifesting itself in U.S. companies stuck
in a way, building up cash abroad that they would like, in many
cases, to return to the U.S. to invest here, to use for a
variety of purposes. But, if they do, they would face the
highest tax rate in the world in bringing it back.
So that is a very important driver of why a U.S. company is
not a particularly attractive candidate when they go out to buy
a foreign company. If you are a shareholder in a foreign
company and a U.S. company says, ``Gee, I would like to buy
you,'' you realize that that means that if you are acquired,
any foreign profits that will be distributed to you have to go
through the U.S. corporate income tax system. If you are
purchased by a foreign acquirer, that is not the case. So it
makes it harder for U.S. companies to make foreign
acquisitions. It makes it harder for them to even invest back
at home.
Senator Thune. And there seems to be a misperception about
this--the way that some of this has been covered at least in
the press articles. It is implied that U.S. companies are
somehow changing the taxation of their U.S. income through
these deals.
Is it not the case that income earned in the United States
remains subject to U.S. tax regardless of the corporate
structure?
Dr. Merrill. A U.S. company that moves its legal
headquarters abroad is still subject to U.S. income tax on its
U.S. operations and is still subject to tax if it brings back
the foreign earnings that it has previously earned in its
foreign affiliates.
Senator Thune. This is a question--one more, Mr. Chairman?
The Chairman. Of course.
Senator Thune. There is the suggestion in the
administration's proposal that we attempt to stop corporate
inversions. But there is a concern that some of the steps that
are being taken, that are designed to stop them, actually could
cause more harm than the inversions themselves.
In particular, there is a concern that this management
control test that is being advanced by the White House and some
here in the Senate could have the effect of encouraging
mergers, whereby management control would be outside of the
United States.
What is your view on that issue?
Dr. Merrill. Congress has a long history of trying to
address inversion transactions, and each time it has produced
unintended effects. Congress tried in 1984, the IRS tried about
10 years later in 1994, and, of course, Congress in 2004
adopted legislation, each time trying to deal with the
transaction of the day. What happened is companies found
different ways to achieve what the economic incentives are
driving them to do, which is to have the assets owned in a tax
jurisdiction that is more favorable.
So the concern would be that another stopgap measure could
lead to the kinds of transactions that are not desirable from a
U.S. standpoint, a true foreign acquisition of a U.S. company
where the headquarters jobs are abroad and the U.S.
headquarters shrinks.
Senator Thune. Mr. Chairman, I thank you. I appreciate the
answers to these questions, and I would ask if I could get my
statement, my entire statement, which I did not use all of,
included in the record and, again, point out that we have a
problem here. The problem is our tax code.
The Chairman. Without objection, it is so ordered.
[The prepared statement of Senator Thune appears in the
appendix on p. 101.]
The Chairman. Senator Thune, you may not have been here
when I made this point. I am fully committed to working with
you and colleagues on the other side of the aisle for the
ultimate cure, which is fixing this dysfunctional mess of a tax
system.
The question is, what are we going to do about the damage
that is being done right now?
Senator Portman, do you have any other questions you would
like to ask?
Senator Portman. Thank you, Mr. Chairman. Why don't you go
ahead, and then I will?
The Chairman. I have no other questions.
Senator Portman. Can I just do a quick, quick round with
the team here?
The Chairman. Of course.
Senator Portman. First of all, I quote you all the time,
because Chairman Wyden makes the point that the tax code is 100
years old and it looks like it. So I appreciate your attitude
about wanting to pursue reform. I am concerned that by taking
this detour, it is going to make it harder, not easier, and,
again, there may be the unintended consequences we talked
about, including accelerating this acquisition of U.S.
companies by foreign entities.
By the way, the Joint Committee on Taxation, which is our
official nonpartisan scorekeeper, has said, with regard to the
President's proposals that were in his budget last year--Mr.
Stack went through those in his testimony, and they are mostly
international tax revenue raisers to deal with some of these
issues--they said, and I quote, ``Many of these proposals may
make corporate structures with a domestic parent relatively
less attractive than corporate structures with a foreign
parent, and these proposals are likely to raise U.S. tax
liabilities for the domestic parent structure more than the
foreign parent structure.''
That seems pretty clear--and that is not Republicans or
Democrats; these are our nonpartisan arbiters as to what we
ought to be doing in terms of good tax policy.
I guess one question that I would love to hear about from
this distinguished panel is--Dr. Robinson talked a little about
access to capital, and the most efficient flow of capital,
obviously, is a big disadvantage to U.S. companies now. So
forget the rate, even forget kind of the general notion of
territorial versus worldwide. The fact is these U.S. companies
are not as nimble. They cannot move assets around where they
need them, and I think that has to be addressed.
Here is my question. Sometimes when I debate my colleagues
on this issue, they say, well, just because a company is
foreign does not mean they do not have U.S. jobs, which is
true. Anheuser-Busch still has U.S. jobs. They sell a lot of
beer in America. Their market share is in good shape.
Maybe, Peter, if you could address this or Dr. Desai or Dr.
Robinson, whoever has looked into this. But can you tell us a
little about what happens when one of our--Peter talked about
Fortune 500 companies over the last 15 years, where you have
seen a one-third reduction in U.S. companies.
What happens? What is the impact on jobs when you see U.S.
companies being acquired by a foreign company?
Dr. Merrill. I have not actually studied that issue. It
could go either way. If the foreign company is a better-managed
company, has better management and brings in new technology, it
could increase jobs. On the other hand, it could go the other
way, but I do not know what the actual experience has been.
Senator Portman. Dr. Desai?
Dr. Desai. I think you are right to put this in the context
of the broader market for corporate control, which is I think
really the issue with foreign acquisitions. And I think the
issue of foreign acquisitions is, particularly with respect to
high value-added headquarter jobs, those may well get relocated
when it becomes foreign-owned.
That is something that we have seen at least anecdotally,
and we also know that headquarter jobs are really important.
They give rise to lots of economic spillovers more generally.
So for that reason, I think you are right to be suspect of the
potential harm of these foreign acquisitions, which is they can
lead to high value-added jobs going abroad and, in particular,
headquarter jobs.
Senator Portman. Dr. Robinson, have you done any research
on this?
Dr. Robinson. I was going to say I do not have anything
concrete to add. I have not done any research in this area.
Senator Portman. Let me just insert something that I find
pretty obvious. When a company chooses to domicile somewhere
else, and particularly when the headquarters moves, which often
happens, as Dr. Desai says, there is an intangible impact.
So the companies in our great cities in America are major
benefactors. Companies in my home State of Ohio are involved in
every single nonprofit in one way or another and often provide
a lot of executives to help to lead these nonprofits and
charities and, obviously, make huge contributions, and I would
love to see some research on that, because I do think this is
sort of the intangible impact of companies pulling out of the
U.S. that has not been given adequate focus and research.
So, if any of you all have any thoughts on that, I would
love to see if we could look into that. So certainly, on the
jobs front, we would like more information, but also on this
sort of intangible benefit.
What happens? Why does it matter? I think it matters. I
think my colleagues do. That is why Senator Wyden and others
are working hard on this. But I think we need better
information to be able to explain this more in terms of the
impacts, the negative impacts, to our constituents.
Thank you, Mr. Chairman.
The Chairman. Thank you, Senator Portman.
At this point, I would ask unanimous consent that a
statement by Senator Levin be included in the hearing record.
Without objection, the statement will be included.
[The prepared statement of Senator Levin appears in the
appendix on p. 43.]
The Chairman. Let me leave you all with one thought that we
really have not, I think, gotten into much this morning.
It seems to me that it would be one thing if there were
just a few of these inversions. In other words, if there were a
few of them, we would work, as we have talked about this
morning, on comprehensive, bipartisan tax reform, we would fix
it, and then we would not be back here again in another decade.
Part of what has influenced my judgments is that that is
not going to happen. And I spoke a couple of hours ago about
reports from the financial press about this feeding frenzy.
That is what is actually going on out there. It is not a few of
these inversions that you could put to bed with comprehensive
tax reform. But according to the financial press, it is a
feeding frenzy, where you have the investment bankers going out
to all the possible companies with their slide decks and
saying, ``You had better do this quickly.'' And the reality is
that tax reform is moving slowly and the inversions are moving
very rapidly, and, as I indicated before, I think that is a
prescription for real chaos.
So, as you could hear from the Senators here today--there
was not a lot of shouting and a lot of screaming and finger-
pointing--there is a lot of good will here. And my hope is
that, with your good counsel--it has been a very good hearing,
with very thoughtful testimony--you can help us address both of
these tasks: to close the inversion loophole and then move on
to the great challenge in front of this committee, and that is
the real cure, which is comprehensive, bipartisan tax reform.
With that, the Finance Committee is adjourned.
[Whereupon, at 12:21 p.m., the hearing was concluded.]
A P P E N D I X
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