The winners – and losers – in race to ban inversions

Congress and corporate America are in a dangerous and mutually destructive race: The more lawmakers threaten to ban the practice of inversions—where US based multinationals merge with foreign firms to lower their tax bill– the more firms race to complete the deals while they can. The more deals, the more pressure on Congress to ban them.

And as the market for inversions heats up, the odds lengthen against real reform that could address the fundamental problem with the US corporate tax system.

The Obama Administration and some leading Democrats have tried to stop inversions by vowing to ban the practice retroactively—effectively eliminating the tax benefits of deals that were not completed by last May.

But the market is sending two signals in response: The first is it does not take the retroactivity threat very seriously. The second is that it is worried that the practice may indeed be curbed for future deals.

Hence, the rush to close inversion transactions before Congress acts. In just the past few months, at least a half-dozen US firms have announced they’ve either completed or proposed tax-motivated mergers.

Some of this may be because firms are rolling in overseas cash they want to bring back to the US But in a classic example of unintended consequences, Democratic threats have supercharged the inversions even more.

Of course, there are winners and losers in this gold rush.

Who wins?

The lawyers, of course. I suspect every transactional firm from LA to New York is working overtime on deals. A lawyer friend canceled our lunch for today. Why? You guessed it. He had an inversion to close.

Shareholders of the foreign partners may also come out smiling. I suspect some US firms are paying sweet premiums for their merger partners. Interesting question for shareholders of the US firm: Do the tax savings really justify the price of these shotgun marriages?

Who loses?

The fisc. Each of these deals reduces federal revenues. The Joint Committee on Taxation figures banning the deals would boost revenue by about $20 billion over 10 years. And those estimates were made prior to the latest round of deals.

Tax reformers. As more companies abandon the US tax system by converting themselves into foreign-headquartered firms, business support for reform could fade.

Think of it like this: Lawmakers are talking about cutting the US corporate rate from 35 percent to somewhere between 25 percent or 30 percent, depending on who is talking. The trade-off: Congress would also eliminate tax preferences that benefit some, but not all, US firms.

But firms currently paying high rates (those least able to take advantage of corporate preferences) are the very companies voting with their feet. As they leave, many remaining US firms will already be paying relatively low rates and thus may be less supportive of rate cuts that cost them the very preferences that keep their tax costs down.

And that may be the biggest tragedy of all.

Inversions are not the real problem. They are rather a symptom of the problem, which is that US rates are higher than those in many other countries. Obama and many in Congress would like to treat the disease by lowering US rates and restructuring the tax treatment of US based multinationals. That’s sensible. But the more high-tax firms legally decamp, the harder reform will become.

Thus, the inversion rush is driving a tax policy death spiral, discouraging the very reforms that could make it unnecessary for firms to shift their headquarters overseas. If Congress doesn’t act soon on fundamental reform, the entire exercise may be largely irrelevant.