Plans by Burger King to purchase Canadian coffee-and-donut chain Tim Horton’s would have generated little interest outside the business-watching world — or even in Canada, where devotion to Tim Horton’s is almost religious, which doesn’t make any sense to me either, but just trust me on this one — were it not for the fact part of the deal involves Burger King relocating its headquarters to Ontario.
The rationale is, at least in part, owing to Canada’s substantially lower corporate tax rate.
The practice of purchasing a foreign company and subsequently relocating overseas to realize relative tax advantages is known as “inversion” and has drawn the ire and righteous indignation of liberals everywhere. President Barack Obama and his band of merry levelers have decried the “economic unpatriotism” of corporations doing such things.
The left’s instinctive “solution” is to somehow make the practice illegal, or at least harder to carry out by, for example, raising the necessary threshold of foreign ownership to 50 percent from the current 20 percent. It goes without saying the obvious and economically sensible solution to this non-problem — eliminating the incentive of pursuing inversions by reducing corporate tax rates — absolutely eludes them.
Inversions are simply additional evidence tax rates matter. It’s no coincidence, and little wonder, so many U.S.-based corporations seek such opportunities. The United States currently is saddled with (“boasts” is certainly not the appropriate word) the highest nominal corporate tax rate (which accounts for the combined federal, state and local corporate taxes) in the developed world, at 40 percent.
America is also the only developed nation to tax the profits a company makes abroad once those profits are repatriated. Naturally, most companies avoid this double taxation by simply keeping those foreign earned profits in the countries where they were made and taxed the first time.
The brilliant author Amity Shlaes recently wrote about how Canada and the U.S., under respective current management, have in recent years swapped economic roles. Canada has suddenly becoming the land of economic freedom and opportunity while America struggles under, as Shlaes astutely observes, its unique version of Pierre Trudeau, the socialist prime minister of Canada during much of the late 1960s and 70s, and from under who’s debilitating economic shadow the country has just recently begun to crawl.
Canada over the last 10 or so years has learned (finally) the truth of the simple economic maxim that you get less of something when you tax it. Canada has decided that it wants investment, jobs and business growth. Accordingly, it lowered the cost of doing business in the Great White North. Canada’s nominal corporate rate is 14 points lower than America’s at 26 percent.
The U.S. could, of course, become more competitive and keep the Whopper red, white and blue simply by reducing the federal corporate rate to a point where the nominal rate is below that of competing nations or at least below the average of the industrialized world.
Corporate taxation results, structurally, in double taxation. A company’s income is subject to a 35 percent federal income tax, plus the appropriate state and local taxes —accounting for, on average, the 40 percent figure. The remaining 60 percent is distributed to shareholders, where it is again taxed as personal income. Even after common deductions and loopholes, the average tax burden of a corporate shareholder is around the 50 percent mark. So a corporation’s board of directors, which has a fiduciary duty to shareholders, looks around and finds a place to do business and return more profits to shareholders. It’s not a difficult decision.
To be sure, the tax question is only part of BK’s decision to emigrate. It appears to be a good deal in other respects, merging a tight-margin fast food chain with a smaller, but more profitable, coffee-and-donut chain with a unique international marketing opportunity.
And one might argue the annual tax savings, as substantial as they will be, might not by themselves be at the make-or-break level. But when looked at in conjunction with other external factors straining slim margins — the specter of a minimum wage increase and labor issues among them — tax rates take on even greater importance.
Here’s the takeaway: If U.S. politicians want to keep businesses headquartered in the U.S. and maintain or increase government revenue, they will support policies that A) reduce the corporate tax rate, after which they can B) eliminate deductions and loopholes that high rates incentivize corporations to seek. Of course, an even better policy would eliminate the need for B), because business should not be taxed in the first place.