Corporate “Inversions” Benefit US Tax Collections (Continued)

By Roman L. Weil

“An inversion makes funds available for US investment
that would not otherwise happen.”

Assume a US company has operations in Ireland taxed there at 15 percent. (The real rate is about 12.5 percent, but the arithmetic is easier if I use 15 percent.) Assume the company earns $1,000 in Ireland. Assume the company can earn 10 percent per year on its investments.

Company earns $1,000. Holds $1,000 in cash.

Company pays 15 percent, $150, to the Irish tax collector. Now holds $850 in cash.

If Company invests the cash in any country other than the US, it will earn a return on $850. It will invest in, say, Germany and earn $85 per year before taxes.

If Company invests the cash in a US project or factory or in paying US workers’ wages, it must first pay the US IRS 20 percent of the earnings, so that total taxes are 35 percent. If Company does that, it will hold $650 in cash to invest. The investment will earn $65 per year. For the investment in the US to do as well for the company as investing in Germany, it needs to earn $85, or 13 percent.

Today, the US company sits on $850 in Ireland. It can invest the entire $850 anywhere in the world, except the US.

That $850 has already avoided US taxes, and so long as the company keeps the cash, or investments of it, abroad, it will not pay the US taxes. This is already happening. Inversions don’t affect the fact that GE, for example, has $110 billion of accumulated after-tax foreign earnings abroad, of which I estimate it earned $22 billion in 2014, that it says will indefinitely keep abroad.

The estimates I’ve read suggest that corporate America has about $2 trillion abroad similar to GE’s $110 billion. The $2 trillion (including GE’s $110 billion) is the accumulation over the past of the amounts equivalent to the $850 in my example. The estimates suggest that about $1 trillion of the $2 trillion is cash or cash equivalents.

Do you think that if our Company could invest the entire $850 in the US, or if GE could invest the $110 billion in the US, they might invest some of it in the US? Here, you have to estimate. I think it’s a good guess that if the companies could bring the entire amount home without paying further tax, they would bring at least 5 percent of that.

Five percent of $2 trillion is $100 billion. Conservatively, I guess that if the companies could bring the funds to the US to invest or pay wages or dividends, we’d see at least $100 billion coming home.

That $100 billion would produce income of $10 billion per year, which results in about $3.5 billion in taxes paid to the US, at the marginal, statutory rate.

So far, I’ve not mentioned inversions. The discussion above applies in today’s world with today’s rules. To get the entire $2 trillion eligible for investment in the US without further US taxes requires a change in the tax system so that the US would match the rest of the world.

The inversion strategy involves the US company buying a foreign company and making the foreign company the parent of the US company. Any earnings of the new company in the US pay US taxes, but foreign earnings will not ever need to pay US taxes.

An inversion allows our companies to bring earnings each year like the $850. Disclosures in GE’s annual report say that its 2013 pre-tax earnings abroad, like our $850, exceed $10 billion. I estimate from disclosures in GE’s annual report that its average tax rate on this foreign income is between 25% and 29%, so after-tax foreign income for 2013 is at least $6 billion. If GE represents 5 percent of US companies’ foreign income, as its $110 billion is 5 percent of the total $2 trillion, then, each year, US companies earn about $120 billion outside the US shielded from US taxes, at least temporarily.

If inversions induce only 40% of that $120 billion to come back to the US, the increased US investment will be $48 billion per year. That will produce about $4.8 billion per year of taxable income for each year after the initial investment, or about $1.7 billion per year in increased US tax collections at the marginal rate of 35%. In the second year, that will mean $3.4 (= 2 x $1.7) billion; in the third, $5.1 (= 3 x $1.7) billion, and so on. After a decade of this, the annual tax collections will exceed $90 billion per year. If the effective rate of taxation on this addition income were only 10% per year, not 35%, then annual tax collections will exceed an average of $25 billion per year over the first decade of this arithmetic.

The funds, $120 billion per year and $2 trillion accumulated over the past, are already abroad and have already avoided US taxes. These funds are unlikely ever to come back to the US any time soon, without change in the tax rules.

An inversion makes funds available — like the $6 billion for GE — for US investment that would not otherwise happen. These new investments will result in new US tax collections.

An inversion does have some costs, which the Congressional Budget Office estimates at $20 billion over the next decade. (That’s the amount it estimates will be saved for the US Treasury if anti-inversion statutes and regulations, now proposed, take effect.)

If we allow, even encourage, inversions, we’ll cost the US about $2 billion per year in reduced tax collections, but increase tax collections by, I guess, at least $25 billion per year and likely more if the US companies bring home more than 40% of the funds now indefinitely invested abroad.


1 If, rather than invest the funds, the company used them to pay current wages or taxable dividends, then all of the income tax increase will happen in the first year. It will have smaller nominal amount, but about equal present value.

2 Sum 1 for the first year, 2 for the second, 3 for the third, … 10 for the tenth and you get 55 (= 11 x 10/2); 55 x $1.7 = $93.5.

Please comment below.

Back to Yale ’62 Home

2 comments to Corporate “Inversions” Benefit US Tax Collections (Continued)

  • Since I wrote the notes Chris published here, I’ve done more work and updated the piece. Write me and I’ll send it to you. I’ve clarified and corrected an error or two. For example, it’s the Joint Committee on Taxation, not the CBO, whose estimates I mean. And now over $2 trillion. And the new version has some of the counter arguments from my colleague and Yalie [‘ 91] Austan Goolsbee, former chairman of Obama’s Council of Economic Advisors. Ed Kleinbard of USC warns that unfettered inversions invite what he calls stripping–the use of loans from the foreign parent to the US subsidiary to reduce the US sub’s taxable income and to reduce the US tax collections. I can’t be sure that the Joint Committee’s work took that stripping into account. I am confident that the Obama rants don’t take into account the fact that the $2 trillion has already escaped US taxes and is already abroad earning income and taxes for some other countries.

  • Larry Prince

    Roman’s analysis shows (once again) that the road to Hell is paved with good intentions … or at least unintended consequences. Roman didn’t mention that current tax law and the proposed law on preventing inversions are very strong incentives for US companies to use their off-shore profit to invest in manufacturing overseas and reduce their employment in the US.

Leave a Reply to Roman Cancel reply