Tax Inversions and Carbon Taxes

Because the US has the highest corporate tax rate in the world, firms can save billions of dollars by attaining a new corporate address in a low-tax country without physically relocating any of their existing business. To do so, American firms simply need to acquire a foreign firm and reincorporate the newly formed company abroad. Since 2012, 12 US firms have successfully moved offshore and many more are attempting to follow, including AbbVie, in a deal to buy British-based Shire for $55 billion and Medtronic’s deal to purchase Irish device maker Covidian for $43 billion. This strategy is known as a “tax inversion” and this post explores how a tax on carbon can help prevent them.

Not surprisingly, inversions cost the US treasury tax revenue, and the recent wave of new inversions has caught the attention of the White House and members of Congress. In July, Treasury Secretary Jack Lew called for “economic patriotism” in an effort to persuade Congress to act on the matter and President Obama declared, “I don’t care if it’s legal. It’s wrong.” Just last week, Democratic Senators called for unilateral executive action and both Secretary Lew and President Obama announced an examination of whether or not the Treasury has the authority to “discourage some of the folks who may be trying to take advantage” of inversions.

Yet inversions are simply a symptom of a much wider problem: our broken corporate tax code. High marginal rates, large loopholes, and a system that tries to tax profits earned abroad puts US companies at a disadvantage relative to their foreign competitors, promoting inversion. Instead of focusing on inversions, our policymakers should concentrate their efforts on meaningful corporate tax reform.

So how would a tax on carbon prevent tax inversions? Carbon taxes have the potential to raise billions of dollars each year that could finance the type of tax reform that would make US corporations more competitive and reduce their incentive for inversion. Further, a carbon tax combined with corporate tax reform is an extremely efficient method of reducing harmful greenhouse gases. In a recent RFF discussion paper, my coauthor Lawrence H. Goulder of Stanford University and I show that the most cost-effective carbon tax is the one that uses its revenues to finance corporate tax rate cuts.

While the political landscape has not been kind to recent so-called “grand bargains,” a bill that establishes a carbon tax while reducing corporate tax rates could satisfy members on both sides of the aisle. My grand bargain would give Democrats an efficient and legally binding climate policy (to replace the less-efficient and legally uncertain EPA power plant rules) and it would give Republicans meaningful corporate tax reform. Sounds like a win-win to me.

About Marc Hafstead

Marc Hafstead is a fellow at Resources for the Future. His research spans environmental and macroeconomics, with an emphasis on developing detailed dynamic general equilibrium models. Within environmental economics, he models the effects of alternative environmental policies such as carbon taxes, cap-and-trade programs, and clean energy standards in economies with multiple non-environmental frictions and distortions on key outcomes such as emissions reductions, welfare, and employment. Within the field of macroeconomics, his interests are focused on measuring the impact of micro-frictions on aggregate outcomes and the implications of those frictions on macroeconomic and monetary policy.

Views expressed above are those of the author. Resources for the Future does not take institutional positions on legislative or policy questions. All information contained on Common Resources is intended for informational and educational purposes and may only be used for these purposes. Please see RFF's Terms of Use for further information.

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