Wednesday, January 20, 2016

Tax Policy Colloquium, week 1: Eric Talley's "Corporate Inversions and the Unbundling of Regulatory Competition"

Yesterday we began Year 21 of the NYU Tax Policy Colloquium. It occurred to me that I have been doing the Colloquium for more than half of the adult portion of my life, whether we date if from my first being eligible to drive (other than on a learner's permit), to vote, or to drink. At least we haven't yet reached the point where the age of the colloquium exceeds that of any student in the class (given that we don't have undergraduates). But that is not so many years off.

My co-convenor this year is Chris Sanchirico, and the speaker for Week 1 yesterday was Eric Talley, We discussed his recently published U Va Law Review piece on corporate inversions.

Because the sessions are off the record (although it is not as if a lot of Page Six-worthy stuff happens at them), my procedure here is to focus just on the paper and my reactions to it, as opposed to discussing what happened at the session.

Talley's paper takes advantage of his expertise in corporate governance and securities law to offer an insight that was not, so far as I know, familiar to tax people who have been thinking, talking, and writing about corporate inversions. Certainly it was new to me. He notes that recent moves towards the effective federalization of U.S. corporate governance law have potential implications for taxpayers' interest in engaging in corporate inversions that cause a given multinational to have a non-U.S., rather than a U.S., parent.

Federalization in this context refers particularly to the enactment of Dodd-Frank and Sarbanes-Oxley. Whether these laws are good, bad, mixed, or indifferent, one effect they have is to move legal provisions that are relevant to corporate governance, managerial discretion, etcetera, from the state level (such as Delaware corporate law) to the federal level.

The reason this matters to inversions is as follows. Suppose the relevant choosers (be they the managers who direct corporate planning, or the shareholders and other investors, if their preferences constrain or influence management) like Delaware corporate law. An inversion that makes, say, Dutch, Swiss, U.K., or Irish corporate law the relevant body will have the disadvantage, to the choosers, of supplanting Delaware law.

But so long as the company's stock is still traded on U.S. markets post-inversion, the federal regimes, such as Dodd-Frank and Sarbanes-Oxley, continue to apply.  So one doesn't opt out of them by inverting, even though one does effectively opt out of Delaware.

To get Delaware corporate law, you have to be incorporated in Delaware, with the inevitable consequence that the company is a U.S. tax resident. But if you want Dodd-Frank and Sarbanes-Oxley (which is not to say whether companies DO generally want them), you don't have to be U.S.-incorporated.  In short, in the paper's lingo, we have unbundled them from the requirement that one be treated as a resident U.S. company.

It is possible that this change, by allowing U.S. companies to invert without as fully exiting U.S. corporate governance law, has made inversions more attractive to some companies than they would otherwise have been. Of course, the magnitude of this effect is unclear. But I'm less sold on the paper's analysis of bundling corporate governance services with makng one accept resident taxpayer status. Under the paper's basic model, this functions as the means of (a) funding the costly provision of corporate governance services and (b) permitting corporate tax revenues to be collected, up to the value that choosers place on those services.

Some particular points I might make, in questioning the bundling model, include the following:

1) How costly is it to provide governance services? Of course they don't cost zero, but are they significant enough to make a model that emphasizes them especially useful?

2) Even if governance services are costly and funded by choosers, why fund it this way? The residence-based aspect of corporate income taxation presents a rather odd funding model for corporate governance services.  Note that companies that act in the U.S. are taxable here on a source basis anyway. So what I mean by the "residence-based aspect of corporate income taxation" is (a) the issues around deferral for profits stashed abroad and (b) the greater difficulty in some respects of profit-shifting out of the U.S., if one is a resident U.S. company.

3) Note that corporate governance services are not currently funded by choosers in the manner that the model envisions. Extra corporate income tax revenues to the federal government don't pay for Delaware's corporate law regime, and (as the paper notes) U.S.-listed companies don't distinctively pay for Sarbanes-Oxley and Dodd-Frank.

4) Suppose you have a public goods argument for the federalized corporate governance rules, e.g., based on systemic risk to the economy or the general benefits of having well-functioning and transparent corporate securities markets. These aspects can't be funded via value provided to the choosers, given the public goods aspect. So they can only be funded through general revenues or some other dedicated source that relies in some different way on the governance jurisdiction's market power.

BTW, what would I do about inversions, at a more general level than simply tightening the inversion rules? I think the key elements are (1) addressing the $2.3 trillion buildup in public companies' "permanently reinvested earnings" abroad, such as via mandatory deemed repatriations of some kind, (2) changing the U.S. rules' current relative over-reliance, in combating profit-shifting by multinationals, on (a) CFC rules that only apply to resident companies relative to (b) rules that apply comparably to all multinationals (e.g., thin capitalization rules), and (3) perhaps broadening the grounds on which a given company will be deemed a U.S. company (e.g., headquarters location in addition to place of incorporation).

But the paper makes a nice contribution by raising the issue of governance-federalization's effects. It also argues that the inversion wave is likely to exhaust itself faster than many have been assuming, due to the relative scarcity of suitable foreign "dance partners" for U.S. companies.  This, in turn, reflects both (1) the substantive requirements for tax-effective inversions that have been put in place since the last corporate inversions wave, and (2) companies' apparent preference, at least so far, in confining inversions to those that are at least arguably strategic (i.e., involving companies in the same industry - such as Burger King and Tim Horton's, or Pfizer and Allergan.

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