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High Corporate Tax Rate and International Mergers & Acquisitions
Cengage
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High Corporate Tax Rate and International Mergers ...

Contributing Author: Debra Sanders

The US corporate tax system pre-tax reform was a systemic problem for United States companies trying to compete in the global mergers and acquisition (M&A) market, according to a 2017 Ernst & Young (E&Y) report. The high tax rate in combination with a worldwide taxing system hindered United States companies in being competitive in their bids for international M&A deals.

Pre-tax reform, the US had the highest marginal tax rate among the leading economic nations. This was not always the case. The Tax Reform Act of 1986 reduced the corporate tax rate from 46% in 1985 to then one of the lowest among these same nations (34% in 1988). In 1993, it increased slightly to 35%, but was still below Germany (50%), Ireland (40%), Italy (52%), Japan (37.5%), and within 2% of the UK rate (33%).

While the United States retained its top tax rate of 35%, the developed countries were dramatically slashing their top rates as they recognized the enticement lower rates are in attracting multinational companies (MNCs). As of 2017, Germany’s rate was about 16%, Italy 24%, Japan close to 23.5%, UK 19%, and Ireland one of the lowest with a rate of 12.5%. Even the US border countries had far lower rates with Canada at 15%, and Mexico at 30%.

To exacerbate the situation, the Unites States was only one of a handful of nations still utilizing a worldwide tax system; most developed countries had moved to territorial taxation. A worldwide system taxes U. S. based MNCs on their global income. Paying the tax can be postponed if the foreign income remains outside the United States. Taxes are only paid when the funds are repatriated. U.S. MNCs have stockpiled an estimated $2.6 trillion offshore to avoid taxation. A territorial tax system would exempt this $2.6 trillion from taxation if repatriated.            

Due to the high corporate tax rate, The E&Y report calculated that the United States lost up to $510 billion in business assets from 2004 to 2016 through acquisitions by foreign companies. Cutting the rate from 35 percent to 20 percent, E&Y estimated that United States entities would have been the net acquirers of cross-border assets to the tune of $1.2 trillion and 4,700 companies would have remained in the United States. These results are based on examining 97,500 cross-border mergers and acquisitions among 68 countries.

CRITICAL THINKING:  But if the US corporate tax rate had been 20 percent and all of the speculated M&A had occurred, how many of them would have been successful? Numerous studies have evaluated cross-border M&A success rate and it is dismally low, between 10 and 30 percent. One of the major reasons for these cross-border M&A failures is not recognizing the importance of the differences in cultures – the actual companies’ cultures and the countries’ cultures within which the companies are located. These failures result in loss of jobs, reduction in profits, and as high as 50 percent of these deals actually destroying shareholder value. Consequently, one has to ask whether the United States businesses have been harmed or merely spared these failures by the high corporate tax rate.

Ideas for Class Assignments

Tax Research

  1. Have students access the Ernst & Young 2017 report and evaluate the findings. Are there issues that E&Y did not consider? For example, the E&Y analysis only considers a drop in the corporate tax rate. It does not consider that with a drop in rate, there could be other changes to the tax law such as measures to broaden the corporate tax base.
  2. Have the students identify a successful and a failed international M&A deal. Compare the two to determine why one was successful and the other was not.
  3. Have students find and summarize articles discussing the importance of culture in M&A deals. Discuss in class the diversity issues that cultural conflicts spotlight. Do students see these cultural conflicts at their jobs or when they are working in class groups with students of different back grounds?

Tax Policy

  1. From your standpoint, is it beneficial to individual taxpayers to lower the corporate tax rate for the purpose of helping corporations compete in the international M&A market?

Consider the failure rate of these M&A deals.

  1. If the corporate tax rate is lowered, what is the effect on government revenues? Lower rates can encourage more business and thus replace the lost revenues. Was this what happened when the rates were lowered in 1986?

 

Resources

SWFT Chapters         

Corporations: Chapter 7, 9

Comprehensive:  Chapters 20, 25