This commentary originally appeared on Investors.com on August 12th, 2014.
'Inversion" is a word increasingly heard these days in Washington, D.C. In this case, instead of referring to a meteorological condition, inversion applies to tax law.
It occurs when U.S. corporations lower their taxes by buying an overseas company, then transferring their headquarters to the newly purchased foreign firm.
Recent moves in the pharmaceutical industry to reduce tax rates through inversion include Pfizer's failed attempt to buy Britain's AstraZeneca as well as AbbVie and Medtronic, both of which purchased Irish companies.
But the opposite can occur as well, with a foreign firm buying an American company, then improving profitability of the U.S. takeover target by reducing its tax burden through the simple device of moving its headquarters out of the U.S.
This may happen with Canada's Valeant Pharmaceuticals International and its $53 billion hostile bid to acquire Irvine, Calif.'s Allergan. (When I served in the California State Assembly, Allergan was my district's largest private-sector employer.)
It appears Valeant's leadership believes that Allergan's components would be far more valuable if they were taxed at Canadian rates rather than the combined tax rates of the U.S. and California (California's corporate taxes are among the highest in the U.S.).
Valeant expects about $2.7 billion in cost savings from the deal, part of it in tax-rate reductions and some in axing R&D expenses. Valeant's prior large buyouts include Bausch & Lomb for $8.7 billion and Medicis for $2.6 billion.
That corporate leadership, seeking to maximize profits for shareholders, would seek international deals to legally reduce taxes shouldn't surprise anyone, especially if they've been observing interstate business transactions of late.
For instance, in the past eight years, California has seen the loss of several Fortune 500 business headquarters to Texas, including Fluor, Calpine, Occidental Petroleum (which is spinning off its California operations and moving to Texas) and Toyota.
While federal corporate taxes comprise the bulk of most firms' tax liabilities, state and local taxes have an effect too. The Tax Foundation rates California's tax burden on mature businesses at 34th in the nation while Texas, lacking an individual income tax, comes in at 12th (a higher ranking meaning a smaller tax burden).
Over time, taxes add up, forcing companies to send more money to the government while cutting back on research, growth, employee pay and benefits, and shareholders. It's simple math.
As international businesses constantly seek higher efficiencies, tax inversions are growing in popularity — so much so that President Obama recently labeled the practice "unpatriotic" while calling on Congress to stop them.
As with other policy matters, the Obama administration is looking at taking administrative actions to curb international business mergers for the purpose of reducing tax obligations. Such administrative action would likely carry with it unhelpful unintended consequences.
Republican leaders in Congress also want to end inversions but propose a different solution: a reduction of the 35% top federal tax rate on corporations, one of the highest in the world.
The question of which approach to take and how quickly it needs to be done has taken on greater urgency in recent weeks as international business deals to reduce tax burdens have accelerated. The Congressional Research Service lists some 50 U.S. firms in the past 10 years as having merged or acquired foreign companies to leverage tax savings.
Absent congressional action to reduce America's high corporate taxes, we should expect to see a continued flight of corporate offices from America's shores.
Moving headquarters overseas may be "unpatriotic" in the eyes of some politicians — but staying put to pay higher taxes while handing the financial advantage to your competitors? That's just foolish.
DeVore is vice president for policy at the Texas Public Policy Foundation. From 2004 to 2010, he served in the California State Assembly, where he was the vice chairman of the committee on revenue and taxation.