Last week, Manhattan District Attorney Robert Morgenthau raised the stakes dramatically in the debate on corporate tax inversions. He is now threatening to criminally prosecute corporations that reduce their New York taxes by relocating their legal residences to a foreign country.
Not coincidentally, Morgenthau simultaneously brought tax evasion charges against Dennis Kozlowski, recently ousted as chief of embattled Tyco Corp., for failing to pay sales taxes on expensive art purchases in New York.
Morgenthau made it crystal clear that there was a direct relationship between his indictment of Kozlowski and Tyco's reincorporation in Bermuda a few years ago. "We were interested because of the fact that Tyco has a nominal headquarters in Bermuda that enables them to avoid U.S. taxes," he said.
The message to other corporate executives with companies based in New York could not be clearer: Those who try to save taxes for their shareholders by reincorporating abroad run the risk of going to jail. The effect was suddenly to criminalize a public policy debate that has been going on in Washington for some months. It also makes a mockery of the longstanding and well-understood difference between legal tax avoidance and illegal tax evasion.
In a famous 1947 case, the great Judge Learned Hand strenuously defended the right of all taxpayers, including corporations, to use all the legal resources at their disposal to pay as little taxes as possible. "Nobody owes any public duty to pay more than the law demands: Taxes are enforced exactions, not voluntary contributions," Hand wrote. "To demand more in the name of morals is mere cant."
Morgenthau is seeking to blur that line, taking advantage of public disgust with big corporations in the wake of the Enron scandal, the recent collapse of Tyco for similar misdeeds and general investor unease over the tanking stock market. The logic goes something like this: Kozlowski cheated on sales taxes; he was head of Tyco, a big corporation that misled investors with shoddy bookkeeping; many big corporations, like Tyco, are trying to save taxes by relocating their legal residences; therefore, big corporations that attempt to legally save taxes this way are nothing but crooks like Kozlowski.
The logic may be weak, but what corporate executive is going to take the chance of being hauled before a grand jury to explain why corporate inversions aren't just a fancy name for tax evasion? Morgenthau, whose father was secretary of the treasury under Franklin Roosevelt, is just practicing a new version of the game perfected by tobacco lawyers, Jesse Jackson and other de facto extortionists. He is hoping that the mere threat of prosecution will halt the inversion game and preserve New York's ability to overtax its resident corporations.
It is a dangerous game that Morgenthau is playing. New York is already a much less desirable place to do business since Sept. 11, and technology is making it increasingly easy for businesses to operate efficiently far away from major city centers. He may prevent a few inversions with this high-stakes maneuver and temporarily save a few tax dollars for New York, but in the long run he is going to scare a lot of businesses away from the city, costing it far more revenue than Morgenthau may be saving today.
The fact is that corporate inversions are not illegal or even immoral by Hand's definition. It is the equivalent of an individual moving from high-tax Massachusetts to low-tax New Hampshire, while continuing to work in Boston. People do this every day after making a calculation about the taxes they pay relative to the benefits they receive from local governments.
I would like Morgenthau to explain just exactly what benefits Tyco or any other corporation gets for being based in New York, as compared to some other state? In New York, it pays 7.5 percent of its profits to the state simply because it has chosen to incorporate there. If the same company moved its headquarters to Florida, it would pay only 5.5 percent, according to the Federation of Tax Administrators.
Keep in mind that we are talking only about legal residence. Property, sales and personal income taxes would be still levied on plants, actual business operations and employees, as appropriate.
The answer, I think, is that most companies get nothing from New York to justify paying it higher taxes. It is also hard to see what a company gets by being legally based in the United States, as compared with Bermuda. In short, the question is not how to prevent corporate inversions, but why aren't there a lot more of them?