ACT Company Spotlight: Emerson and the U.S. Tax Code
Wall Street Journal: Why Corporate Inversions Are All the Rage
July 28, 2014
By Walter Galvin
Senate Finance Committee Chairman Ron Wyden (D., Ore.) recently called the American tax code a “rotting mess of a carcass.” The phrase captures how repugnant the current tax system has become—and perhaps most repugnant is the U.S. tax treatment of corporate income, especially from foreign sources.
The U.S. has the highest corporate income-tax rate in the developed world. While U.S. corporations face a combined federal-state statutory tax rate of 39.1%, our competitors in the Organization for Economic Cooperation and Development (OECD) face an average rate of 25%.
According to Laura Tyson, former chairwoman of President Clinton’s Council of Economic Advisers, “America’s relatively high rate encourages U.S. companies to locate their investment, production, and employment in foreign countries, and discourages foreign companies from locating in the U.S., which means slower growth, fewer jobs, smaller productivity gains, and lower real wages.”
At the same time, the U.S. adheres to a system of international taxation discarded by most other countries. American businesses are taxed on a world-wide basis regardless of where in the world revenue is earned. That means U.S. multinationals pay taxes twice, first to the foreign country in which they do business and then to the U.S. after they repatriate their profits. In 2010, the latest year for which there is IRS data, U.S. multinationals reported paying $128 billion in corporate taxes to foreign countries.
As with the relatively high corporate tax rate, America’s world-wide system of taxation hinders growth, encourages companies to relocate outside of the U.S., makes U.S.-based companies vulnerable to foreign takeover, and puts American businesses at a competitive disadvantage internationally.
At Emerson, the St. Louis-based manufacturing and technology company where I retired last year as vice chairman, the business has seen and experienced the deleterious effects of the U.S. tax code firsthand. Here is one example:
In 2006, Emerson sought to acquire a company called American Power Conversion (APC). This was a Rhode Island-based company that made more than half of its earnings outside the U.S. Unfortunately, Emerson competed against Schneider Electric, a French company, to acquire APC. Emerson offered more than $5 billion, but ultimately Schneider acquired APC by offering a bid in excess of $6 billion.
Why was Schneider willing to offer more? Schneider outbid us because France’s tax code—typical of most OECD countries—exempts 95% of foreign-source income from taxation, while the U.S. tax code fully taxes such income. APC’s profits were worth more to Schneider because, once absorbed, APC’s global profits (net of the taxes paid in the countries where those profits were earned) could be repatriated to Schneider’s headquarters in France, where they would be taxed at less than 2%.
In contrast, earnings repatriated to the U.S. are subject to a tax rate of nearly 40%, with a credit for taxes paid abroad on that income. That dramatic difference made it possible for Schneider to offer more for APC. So what had once been an American company became French.
The U.S. tax code also encourages American companies to hold foreign-source income abroad to avoid the additional layer of U.S. tax. Recent estimates peg the total currently held abroad at $2 trillion. There is a logical reason for this behavior.
In 2010, for example, Emerson bought a U.K. company called Chloride for $1.5 billion using revenue earned abroad. Emerson had considered other options for that cash, including bringing it home to the U.S., but the U.S. tax code made repatriation unattractive. It would have cost us an extra 10 to 15 cents in taxes on every dollar to bring that money home. It made much more sense to invest a dollar in the U.K. instead of 85 cents in the U.S.
It’s time for Congress to reform a tax system that mainly benefits other countries. Other countries have learned this lesson already—both Japan and the U.K. have adopted a modern hybrid international system and lowered their corporate tax rates in recent years. The U.S. needs to learn from their examples and fix the broken tax system now.
Mr. Galvin is the immediate past chairman of the National Association of Manufacturers’ Tax Committee.