Tax inversions don’t destroy US jobs

The now-abandoned merger between pharmaceutical competitors Pfizer and Allergan (located in Ireland) has reignited debate over a longstanding hobby horse of tax reformers: Corporate inversions, where American companies take over foreign firms and incorporate abroad to reduce their tax burdens.

President Obama's charge — he called the practice "unpatriotic" — has taken a backseat to a new line of attack from Republican front-runner Donald Trump: Foreign countries are taking our jobs!

Is this true? In a word, no.

Here's why companies are pursuing tax inversions: The U.S. has the highest statutory corporate tax rate in the world — around 39 percent, including state and local taxes, though effective rates are lower — and maintains a worldwide tax system. This means that all income, minus tax payments to foreign governments, earned abroad is subject to corporate income taxes. But here's the kicker: Companies don't have to pay until they bring the money back into the U.S.

There are two major consequences of such a system. First, companies maintain sizable cash holdings abroad. There is over $2 trillion in so-called "unremitted earnings" in foreign countries, some of which, under a more logical system, would be brought back to the U.S. The second effect is more drastic. When U.S. tax rates are particularly burdensome, merging with a competitor to change your tax home might be particularly attractive.

Kudlow: This is a war on tax inversions

To add insult to injury, most developed countries maintain territorial systems, charging taxes only on the income earned domestically. This means that a global firm headquartered in America is at a competitive disadvantage compared to a firm headquartered in, say, Ireland.

It's plain to see that both inversions and unremitted earnings are a product of the illogical and exacting tax system we've created.

But are these inversions to blame, as Trump charges is happening with Pfizer, for sending jobs to Ireland? Not quite.

Is Israel the new Silicon Valley?

For starters, his critique ignores what actually happens when a company "moves" overseas or merges with a foreign competitor. The company's tax home may change, but the entire workforce isn't packed up and moved overseas. Some key executives may move, some employees may move, but on the whole, employment decisions will be made based on other factors — like where the R&D facilities are located.

But it's not only common sense that cuts against these arguments. Research evidence does as well.

An industry-funded study from Bates White Consulting suggests that, if anything, after inverting firms in the pharmaceutical space, employment actually increases. (While it's possible that foreign employment rises while domestic employment falls, that's an unlikely outcome). That's not to say that inversions lead companies to employ more people — in fact, these firms were already growing their workforce pre-inversion, and simply continued doing so afterward.

Another analysis by Omri Marian of the UC Irvine School of Law indicated that tax-motivated mergers typically haven't resulted in large-scale shifts of "economic attributes" (like a company's workforce). Shire Pharmaceuticals' move to Ireland from the UK, for instance, saw virtually no change in the company's UK workforce.

Of course, inversions can be problematic but dealing with them means recognizing that they are a symptom of something deeper. The Treasury's newly-announced rules, which helped kill the Pfizer-Allergan merger, eliminate many benefits of tax inversions, but retain the U.S.'s uncompetitive tax code and address only the symptoms, rather than the disease.

Election season pains health-care stocks

Any real fix has to focus on moving to a territorial tax system, as former House Ways and Means Chairman Dave Camp had proposed several years back. Under Camp's proposal, current unremitted earnings abroad would be taxed once at a relatively low rate (8.75 percent), and 95 percent of future foreign earnings would be exempt from domestic corporate income taxation. This shift to a mostly territorial system would be more in line with other OECD countries, and would eliminate the need for tax inversions.

But beyond the underlying policy questions, perhaps is an equally big problem in today's rhetoric. The "sending jobs abroad" critique is reminiscent of Smoot-Hawley-esque protectionism, and the fact that it is rearing its head in the presidential election shows that we may be forgetting important lessons that the 90s have taught on the benefits of liberalized trade. Such rhetoric should be left in the dustbin of history where it belongs.

Commentary by Yevgeniy Feyman, deputy director of health policy at the Manhattan Institute.

For more insight from CNBC contributors, follow @CNBCopinion on Twitter.