TRUMP ON TAXES

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New Jersey, you’re going to be OK.

I just wanted to calm Kevin Smith, Snooki, Eli Manning, and any other Garden Staters who might have read Donald Trump’s August 18 TIME magazine interview, in which the one-of-a-kind businessman and presidential candidate declared that Pfizer Corp.’s potential inversion would “wipe out New Jersey.”

First of all, Pfizer is based in New York, although the Donald may have been thinking of Merck & Co., which is based in Kenilworth, N.J. but hasn’t been the planning any U.S. exit

More importantly, though, that isn’t how inversions work.

In a subsequent interview with Bloomberg TV on August 26, Trump said the U.S. is losing “thousands and thousands of jobs” from companies moving overseas to escape the U.S. tax system.

Readers may recall that inversions—in which a U.S. corporation establishes a parent company with a tax residency abroad, usually through a merger with a smaller foreign entity—became a political firestorm last year, as several iconic American companies including Pfizer, Walgreen Co. and Burger King Worldwide Inc. either considered or undertook the maneuver.

Contra Trump, an inversion doesn’t in and of itself involve moving jobs out of the U.S. In fact, it doesn’t have to involve moving anything; it’s just a corporate reorganization following a merger. Everything in the U.S. stays; the difference is that it’s now part of a subsidiary of a larger parent company.

The fact that jobs don’t move offshore in an inversion is what rubs some people—including those in Congress—the wrong way. It seem like plain old cheating for a company to declare an offshore tax residency while leaving its existing U.S. operations and employees--including the CEO and management team--right here at home.

There might be indirect effects—certainly, the new corporate structure would influence investment decisions in the future. And, true, companies need to merge in order to invert, thanks to a 2004 anti-inversion law, with the mergers normally involving a reduction in the number of employees.

But, paradoxically, this reduction is more likely to be felt in the foreign country, not here. Even though the parent company will be registered abroad, its management team will still be in the U.S.--leaving the previous foreign headquarters unnecessary and ripe for decimation.

Inversions aren’t really a jobs issue, but a government revenue issue. They erode the U.S. tax base. And this gets to a problem with Trump’s diagnosis of inversions’ root cause.

“We have $2.5 trillion sitting outside, it can’t come in, and now what’s happening is that companies are leaving this country,” Trump told Bloomberg TV. “We have companies with thousands and thousands of jobs that are leaving this country to go out and get their money.”

Trump is referring to deferred income, which companies can keep “abroad”—it’s still normally held by banks in the U.S.—to avoid having to pay U.S. corporate income tax on it. That is a huge issue in any discussion of the U.S. tax system. 

But an inverted company can’t just “go out and get” that money. Even after the inversion, the income is still held by a subsidiary of a U.S. entity, and the parent company can’t get at it without first running it through the U.S. and triggering the corporate tax. Responding to the public outcry on inversions, last September the White House announced further regulations barring some of the other means inverted companies have used to try to free up that cash, such as intercompany loans. (So Trump’s declaration that President Obama has “done nothing” on inversions is not entirely accurate.)

When a company inverts, its eye may not be on the money it’s hoarded, but on future earnings. Almost always, a U.S. company will invert into a country with a territorial tax system, which means its government doesn’t tax income earned beyond its borders. Especially for Burger King, which is planning aggressive expansion in new markets, that’s an attractive incentive--fewer headaches, and almost certainly lower taxes.  

In some ways, the Trump diagnosis gets it exactly backwards. Inversions aren’t just about grabbing money that’s overseas; they are also about taking money that’s currently in the U.S. and moving it there. Once a company has inverted, it can use intercompany debt to drive up tax-deductible interest payments out of the U.S.—something often called earnings stripping. (The U.S. has laws prohibiting its own companies from using this strategy.) This is important, too, because it affects what solutions are being considered. Even if you take the hoarded offshore cash out of the equation, the incentive to strip earnings may be enough to encourage more inversions. 

To deal with inversions, Trump has argued for allowing companies to repatriate offshore cash at a reduced tax rate. It’s not yet clear whether this would be a one-time voluntary holiday, as Congress passed in 2004, or a permanent requirement. Anyway, see if you can decipher it:

“We should let them back in. Everybody. Even if you pay nothing it would be a good deal. Because they’ll take that money and use it for other things,” Trump told TIME. “But they’ll pay something. Ten percent--they’ll pay something. Every Republican, every Democrat--for years they have all agreed.”

Trump is certainly right that virtually everyone agrees the current U.S. tax system is deeply troubled, and there’s a surprising amount of consensus on the solutions. But many would disagree that bringing that money back free of tax would be a “good deal.” The 2004 repatriation holiday has been blasted for failing to create genuine economic activity--companies used it for “other things,” but those things included stock buybacks and dividend payments, creating very limited trickle-down effects. And while Treasury saw a surge of revenue, the non-partisan Joint Committee on Taxation has scored a temporary holiday as a net loser for the government. Companies used the holiday to repatriate, under a lower rate, money they would have brought home anyway, and it gave them a further incentive to keep future earnings overseas. President George W. Bush, who signed the bill creating the holiday, reportedly felt betrayed by how it turned out.

Does Trump have a proposal about what to do going forward? Does he support, as most of the GOP does, switching to a territorial system? Would he maybe prefer Obama’s approach, which would levy a global minimum tax on worldwide profits immediately? Or would be like to see some sort of hybrid structure, which identifies income that’s easily moved around the globe, but leaves untouched profits generated from brick-and-mortar activity?

We’ll find out in September, when he has promised to release his tax plan. (And, to be fair, he seems to be the only Republican candidate talking about the inversion issue.) Until then, we’ll just have to keep watching the most captivating presidential campaign in memory.