Ed Lotterman: The roots of corporate venue shopping

Special to the Idaho StatesmanJune 27, 2014 

Were he still alive, Judge Learned Hand probably would approve of medical device maker Medtronic's purchase of Covidien, another med tech company with a slightly different product line and a larger legal presence in Europe. Establishing a European foothold favorable to reducing Medtronic's U.S. tax liabilities while still giving it effective access to profits earned overseas to fund corporate growth seems to be an important, though not the only, motivation for the deal. The deal and whatever Rube Goldberg tax avoidance structure it will engender are legal.

Hand, an appellate judge and legal scholar of the past century, reminded us that "over and over again courts have said that there is nothing sinister in so arranging one's affairs as to keep taxes as low as possible" and that "nobody owes any public duty to pay more than the law demands."

So there is nothing legally wrong with a U.S.-based medical device company that already has multimillion-dollar international operations closing a deal that, among other things, reduces its taxes.

The questions are, rather, ones of public policy. Are the laws that permit such deals good or bad? Are companies forced into such deals because of a flawed tax structure out of step with the rest of the world?

More broadly, the merger highlights the issue of the economics and fairness of what is known in legal circles as "venue shopping" and in finance as "regulatory arbitrage."

Is society as a whole better off if a small country such as Ireland enacts laws giving special tax status to multinational corporations? What about if Panama allows ship owners to register their ships in that country with little enforcement of maritime safety laws? How about Delaware attracting business by making its laws governing corporations especially favorable?

What about South Dakota offering banks a blank regulatory check if they move their credit card operations there? Or insurance giant AIG securing itself the legal status of a credit union because that put it under more pliable regulations than a federal commercial bank charter would have?

Legality aside, different people have different reactions to such "loopholes" that often reflect underlying societal interests.

One reaction is that minimizing taxes by establishing nominal headquarters in Ireland or Bermuda is abusive. The firms still have their principal operations here: Medtronic in Minnesota and Covidien in Massachusetts. They still hire people whose education was subsidized by local state and federal governments. They enjoy a U.S. or state government-funded transportation infrastructure and government-funded basic research.

They enjoy a very favorable patent system. They still want the federal government to represent their interest in trade negotiations and in general relations with other countries. Most of their operations continue in areas protected by government public safety and defense expenditures. So why are they trying to weasel out of paying taxes? And why should there be a lower level of effective taxation on the profits of multinational firms than that faced by smaller businesses?

Another reaction is that U.S.-based corporations are unfairly penalized by an outdated, unfair and economically inefficient tax system. Its marginal rate is higher than that imposed by other industrialized nations. It is poorly harmonized with practices in the rest of the world. It is overly complicated and contains perverse incentives. This puts the U.S. at a disadvantage

Moreover, companies like Medtronic are global. The profits that it is trying to shield from U.S. taxation were earned from sales outside the United States and, in some cases, from products manufactured elsewhere. Why should the U.S. government demand a cut?

Both sides have a point. Companies do try to have it both ways, enjoying the benefits of being a U.S. corporation while using every possible legal artifice to minimize taxes paid for those benefits. And the U.S. corporate tax system is a bad one that cries out for an overhaul.

However, even if such an overhaul should occur, corporations will still devote ample resources to try to take advantage of whatever provisions give them possible advantage. And some other nations, like Ireland and Bermuda, will try to skim off "economic rents" by giving international companies very favorable treatment in return for a payoff.

The analogy to countries like Panama or Liberia that are willing to register merchant ships while ignoring crew safety and risk to the environment is a close one. That lax regulation creates external costs that hit third parties and make the global economy less efficient.

At the global level, opportunistic countries could be frozen out of their racket if the major trading nations would agree that ships not meeting standards specified in international pacts be banned from loading or discharging in their ports. But that is opposed by ship owners and by countries such as China that would pay more for importing and exporting.

Nevertheless, such a united front would be little different than the pressures applied in recent years to Switzerland over its banking secrecy laws. The Swiss portray this as defense of individual privacy and autonomy, which it may be. But in effect, Swiss banks have long been accessories to crimes ranging from tax fraud to government corruption

The problem of competition between alternate jurisdictions for business is not going away. But we would be better off if we reformed tax and financial regulation laws to more explicitly recognize the challenge. And more cooperation internationally would be excellent.

Economist Edward Lotterman writes in St. Paul, Minn. Write him at boise@edlotterman.com.

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