Walgreens: The exception that proves the rule [Editorial]

Today's announcement by Walgreens that it would not seek to move its corporate headquarters (for tax purposes, anyway) out of the United States may well be the exception that proves the rule of an inexorable trend toward so-called "corporate inversion." Though some have speculated that potential customer backlash played a role in Walgreens' decision, the deciding factor seems not to have had anything to do with what President Barack Obama has referred to as economic patriotism but rather an unwillingness by the British firm it is buying to restructure a previous deal in such a way that inversion would withstand IRS scrutiny.

Instead, analysts expect the stampede of firms looking for foreign companies to buy so they can incorporate in lower-tax nations to accelerate. By doing so, they can avoid paying the United States' 35 percent corporate tax rate on future foreign earnings and on the huge trove of cash companies have already parked overseas. With some more fancy accounting, inverted companies can reduce the U.S. tax burden on their domestic earnings as well. Analysts estimated that Walgreens' contemplated inversion to Switzerland could have saved it as much as $4 billion over five years.

The answer to this problem is broadly obvious across the political spectrum: Reform the U.S. corporate tax code to simplify it and to lower the rates to be more competitive with other nations. But given the gridlock in Congress, the likelihood of working out the details of such a shift any time soon seem slim. Even stopgap measures have failed to advance legislatively. And in the meantime, the United States risks losing its corporate tax base altogether.

That's why President Obama needs to use his executive powers to make such deals less attractive. Such action may sound like provocation at a time when Republicans in the House of Representatives are preparing to sue him over his use of executive authority — and some are even suggesting he be impeached for it — but the tax code gives the treasury secretary discretion in a few key respects that could remove much of the economic incentive for such deals.

Harvard Law School professor and former administration official Stephen E. Shay offered a roadmap in an article he published last week in the journal Tax Notes. While his suggestions wouldn't make inversions illegal, they would, in the estimation of someone involved in the deals with whom he consulted, stop about 75 percent of them.

One tactic inverted companies have used to maximize their tax benefits is to have the new offshore "parent" make a large loan to its U.S. "subsidiary," which then must make large interest payments overseas. Those interest payments are then deducted from U.S. taxes. But, Mr. Shay writes, the treasury secretary has the authority under current law to change the way such transactions are classified so that the resulting payments offshore would not be tax deductible. In the Walgreens case, he wrote, that change alone would have reduced the tax benefit of inversion by hundreds of millions of dollars.

Another benefit of inversion for U.S. companies is the ability to access cash they have stowed overseas — a total of about $2 trillion. American corporations can't defer U.S. taxes on foreign earnings if that money is used in a way that benefits the parent company, but through inversions they have, effectively, managed to do so. Mr. Shay also offers suggestions for closing, or at least narrowing, that loophole through the interpretation of the existing tax code.

Republicans, though no fans themselves of inversions, have generally viewed Democrats' zeal for the topic as an attempt to highlight a populist economic issue in advance of November's elections. Their response is to insist that only true corporate tax reform can fix this and other aspects of a broken system. But the longer we go without even a stopgap measure to halt what threatens to be a runaway trend, the less pressure there is likely to be from the business community to adopt wholesale reform, and the less consensus there will be on what shape it should take. Inverted companies and non-inverted companies could see things quite differently.

News leaked overnight that Walgreens would keep its headquarters in Illinois, and its shares dropped 15 percent as soon as the stock market opened today. That's a sign of just how big the incentives are for companies to pursue inversion and a guarantee that this trend will not end on its own, no matter how unpopular the move may be. Treasury Secretary Jacob Lew said Tuesday that he is considering taking actions to combat inversions, and he should do so without delay.

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