International corporate tax reform has become a salient issue recently due in part to numerous high-profile corporate inversions, most recently the merger between Johnson Controls and Ireland-based Tyco International. Inversions occur when a corporation relocates to a lower-tax nation by having a foreign company buy its current operations while retaining its material operations in the country of origin (in this case, the U.S.). While just one of many challenges related to the U.S. corporate tax code, inversions have triggered widespread pressure to reform the international tax system. Broad tax reform is high on Speaker Paul Ryan’s (R-WI) agenda, and has been since his time on the House Ways and Means Committee. Though there is bipartisan agreement that an international tax overhaul is important, last year’s negotiations failed to produce any agreements, and there is little indication that this year will be any different. Election-year politics will make comprehensive reform even more difficult, since politicians on both sides of the aisle will be reluctant to make compromises that could hurt their party at the polls. However, the House Ways and Means Tax Policy Subcommittee Chairman Charles Boustany (R-LA) said last week that House Republicans are trying to produce a draft proposal on international tax reform by the end of March, and many lawmakers are eager to do something.

The House Ways and Means Committee held a hearing on Wednesday, February 24, called Global Tax Environment in 2016 and Implications for International Tax Reform that looked at the international repercussions of the U.S. corporate tax system and some of the implications for the American economy and opportunity. Testifying as witnesses were: Michelle Hanlon, Professor of Accounting at the MIT Sloan School of Business, Raymond Wiacek, a Partner at Jones Day Law Firm working on international tax issues, Itai Grinberg, an Associate Professor of Law at the Georgetown University Law Center, and Edward Kleinbard, a Law Professor at the USC Gould School of Law and a Fellow at the Century Foundation.

Chairman Kevin Brady (R-TX) opened with a statement setting the stage for the hearing: Americans are increasingly seeing companies move overseas, and the Committee wants to better understand why and what can be done. He introduced a few elements of the international tax environment that would be discussed at length during the hearing. The first is the OECD’s Base Erosion and Profit Sharing (BEPS) Action Plan, which was agreed upon by G20 countries in 2013 to address perceived flaws in international tax rules; BEPS refers specifically to tax planning strategies that exploit differences between countries’ tax rules to move profits to location with little or no economic activity in order to avoid paying corporate taxes. The second is the European Commission’s “State aid” investigations, being held to assess whether certain tax rulings by Member States constitute illegal State aid. In his remarks, Brady called for a bipartisan effort for pro-growth tax reform. Ranking Member Sander Levin (D-MI), in his opening statement, called for a long-term, full, bipartisan overhaul, while noting that smaller pieces such as inversions shouldn’t be overlooked in the meantime.
In their statements, most of the witnesses agreed that the fact that the U.S. corporate tax rate is one of the highest in the world and is a global tax system puts it out of step with the rest of the world, and everyone agreed that the corporate rate needs to be lowered to remain competitive in an increasingly international corporate environment. Hanlon made the point, which was echoed by others, that inversions, which have garnered so much media attention in the last couple of years, are only a symptom of our deeply flawed tax system and one small piece of the larger problem. It was later noted that acquisitions continue to occur that have nothing to do with inversions but nevertheless result in companies leaving the U.S. Wiacek discussed how the fate of multinational corporations affects the health of the entire American economy. When companies move overseas, he said, the surrounding economies that support those companies also suffer. Many of the Committee members returned to this point during questioning and saw it as a way to impress upon the public the importance of international tax reform. The only somewhat dissenting opinion was by Kleinbard, who cautioned against confusing world-wide macro-economic trends with tax policy, saying that it is more important to think about competitiveness from the perspective of the U.S. business environment rather than from solely an international tax perspective.

Much of the questioning centered on trying to better understand the underlying reasons why companies, especially multinational corporations, are relocating overseas and inverting. Wiacek pointed out that tax policy is not the only factor in competition, but that it does ultimately have an important impact on a company’s bottom line. Members also tried to get a sense of the international environment and what BEPS and EC state aid investigations mean for American tax policy. One impact is that the global environment makes reform in the U.S. more crucial and more pressing; as other countries move ahead with developing competitive tax systems, the United States will be left behind while an increasing number of corporations move overseas. Another possible outcome mentioned was that as part of the state aid investigations, U.S. companies could become pawns in European tax disputes between high-tax countries such as France and low-tax countries such as Luxembourg.

When discussing their views on how to reform the system, all of the witnesses agreed that the corporate tax rate needs to be lowered. All except Kleinbard believed that the international corporate tax rate did not have to be revenue-neutral, a view that was disputed by several members of the Committee. Another idea that witnesses brought up repeatedly was moving toward a consumption-based tax. Grinberg discussed specifically moving toward a dividend exemption system in addition to a lower corporate rate. He argued that the U.S. should move from a worldwide system to a source-based system, such as a territorial system that taxes based on where income is earned rather than the place of corporate residence. One question that came up a few times was whether, despite knowing that inversions are only a symptom of a larger problem, they should be addressed through legislation without broader reform. Witnesses cautioned that prohibiting inversions without lowering the statutory tax rate would do little to solve the problem, since companies could still move overseas or find other ways to lower their effective tax rates. Another possible reform mentioned was the so-called “innovation box,” which is a lower tax rate for income derived from intellectual property. Most of the witnesses thought it was an idea that should be considered, although Grinberg argued that such a tool tends to reward companies for work done years ago.

From a political standpoint, the hearing included numerous calls for bipartisanship and balanced, thoughtful, and pro-growth reform. Rep. Charles Rangel (D-NY) believed that informal discussions would be the most productive approach, rather than formal hearings, given the level of partisanship in Congress. Rep. Jim McDermott, in a more negative statement, called the hearing a “sham,” saying that nothing could be solved in the hearing format and cautioning against trying another failed “repatriation holiday.” Other members discussed the need to effectively communicate to constituents the importance of international tax policy on the everyday lives of American people and the American economy at national and local levels.

Note: Many of the themes that came up in the hearing were echoed in last week’s Brookings Institute conference on tax reform called “Tax policy in 2016: What’s new and what’s next”. The conference, which included two panel discussions and keynote addresses by Rep. Kevin Brady and Sen. Ron Wyden (D-OR), focused the tax policy proposals of the presidential candidates and tax reform proposals circulating in Congress. In the first keynote address, Brady spoke at length about the importance of international tax reform and making American corporations more competitive on an international scale. He criticized the BEPS proposals and EC state aid investigations as unfair to American corporations. Brady affirmed that he would like to see international tax reform happen this year and believed that voters understand the importance of international tax policy on their own livelihoods. In his address to conclude the conference, Wyden, while trying to take an optimistic tone overall, questioned whether comprehensive tax reform would be possible in such a contentious election year. He did, however, call on Congress to “triage the inversion virus” and address other M&A activities to the extent possible. Unlike the Democratic presidential candidates, Wyden called for a version of a territorial system that better encourages companies to develop, innovate, and manufacture in the U.S. He ended his address by calling for “principled bipartisanship” in tax reform proposals in which parties find common ground and borrow the best ideas from each side of the aisle.