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Business Forum: The Problem or a Symptom?

As seen in the Pittsburgh Post-Gazette

The Obama administration urged lawmakers recently to pass legislation to contain the number of companies reincorporating overseas for tax purposes, commonly referred to as corporate inversion. Mylan Labs, headquartered in Canonsburg, is one of the latest companies to pursue such a strategy.

It is perceived by Washington lawmakers that companies such as Mylan are taking advantage of a quirk in U.S. tax law and cheating the government of much-needed tax revenue. Our intuition is that corporate inversions themselves are not the problem, but a symptom of a broader issue the need for broad U.S. corporate tax reform.

In 1986, the U.S. passed landmark tax reform that lowered corporate tax rates to the lowest in the industrialized world. This action set off a chain reaction around the world, forcing other countries to adopt similar measures to attract capital. Today, the U.S. has the highest corporate tax rate in the industrialized world (40 percent vs. the global average of 24 percent) and is the only industrialized country that double taxes foreign sources of earnings.

Under the current tax law, a company that earns a profit in another but wants to return capital to the U.S. pays taxes in the host country and then again when the profits are repatriated back to the U.S.

The tax bite is so meaningful that companies are pursuing inversions, which take place when a U.S. company merges with a foreign business in another tax jurisdiction. With some restrictions, the combined company can choose its tax domicile, which given abnormally high levels in the U.S. will most certainly be overseas. Roughly 50 of such inversions have taken place since 2008, and the pace is accelerating.

Besides U.S. companies reincorporating overseas and the U.S. government losing out on an estimated $20 billion in tax revenue over the next decade, there is a more important long-term impact on the U.S. economy deterring domestic investment.

The double taxation of foreign earnings has encouraged companies to hoard an estimated $1.8 to $2 trillion overseas. These are monies that are left overseas for tax purposes, instead of being returned to the U.S. where it could be directed toward hiring and capital spending.

Capital spending is particularly important to fuel longer-term growth of the U.S. economy. Just as an individual invests in education and professional development to fuel their long-term earnings potential, companies must invest in research and development and upgrading physical assets in order to maintain or increase the scope of operations in the future.

Unfortunately, domestic investment as a percentage of our economy is coming off multidecade lows. This is evidenced by a sub-par economic recovery and recent data suggesting U.S. infrastructure is the oldest since 1958.

Rather than spend time and energy trying to halt corporate inversions, our Washington representatives should pursue broader U.S. corporate tax reform to improve our competitiveness in the global economy.

Lower corporate tax rates combined with closing loopholes was one part of a six-point plan presented by a bipartisan commission created in 2010 by President Barack Obama, otherwise known as Simpson-Bowles, charged with identifying policies to improve the fiscal condition of the U.S. over the medium term and sustainability over the long run.

By lowering corporate tax rates to more closely align with global peers, lawmakers would ultimately halt inversions but more importantly encourage companies to return cash to the U.S. for jobs and investment. Such action would also be broadly positive for domestic growth, stocks and the U.S. dollar.

Americans should closely watch and encourage policy developments on this front due to the potentially far-reaching implication, not only on U.S. markets and employment but on our nations long-term growth potential.

The U.S. cannot expect a robust long-term growth environment without first investing in itself. Attempting to stop corporate inversions is simply focusing on a symptom of a broader issue. To be sure, this is not a partisan issue but an American issue.

Donald M. Belt is chief investment officer of Hefren-Tillotson, a Pittsburgh-based wealth management firm.

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