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The Right Way to Stop Corporate “Inversions”

The Transocean Ltd. logo is displayed on the side of the Transocean Siam Driller jackup rig
Munshi Ahmed—Bloomberg via Getty Images Transocean is an American company that changed its registration to the Cayman Islands and then to Switzerland, lowering its tax rate.

While policymakers try to penalize and shame U.S. corporations from moving their headquarters abroad for tax purposes, they ought to be fixing the country's idiosyncratic tax system.

When I was a boy growing up in Illinois, Chicago Bridge & Iron Co. was a local company.

Today Chicago Bridge & Iron CHICAGO BRIDGE CBI -1.83% is a multinational corporation headquartered in The Hague, Netherlands. The engineering and construction company is just one of numerous U.S. firms to move their headquarters abroad, either through relocation or by being nominally bought by a smaller foreign company.

Among them are: Helen of Troy HELEN OF TROY HELE -0.79% , Ingersoll Rand INGERSOLL-RAND PLC IR -1.81% , McDermott International MCDERMOTT INTL. MDR -0.57% , and Transocean TRANSOCEAN LTD. RIG -1.58% .

Just this week Walgreen WAG 0% dropped plans to follow in their footsteps.

The practice is called “inversion” and all of a sudden inversion is a phrase on politicians’ lips. Senator Dick Durbin, an Illinois Democrat, has proposed banning federal contracts for inverted companies. Treasury Secretary Jack Lew and President Obama have both said they want to discourage the practice, with Mr. Lew citing “economic patriotism” as a reason.

The day that multinational corporations find patriotism a compelling reason to set policy will be the day the tooth fairy presides in the boardroom.

The problem

The root of the problem lies in the fact that the U.S. has an idiosyncratic tax system. If you are a U.S. citizen or corporation and earn money in Germany or Japan, you are expected to pay tax on it to Uncle Sam. Most other countries don’t do it that way. They follow the principle that income is taxed where it is earned.

Of course, corporations have dozens of ways to make sure their income is “earned” in the lowest-cost jurisdiction they can find. I’d like to get Tim Cook of Apple APPLE INC. AAPL -1.49% drunk and see what he says about this. (To Congress, Mr. Cook soberly insisted that Apple’s big Irish unit exists for operational reasons, not tax reasons.)

What’s at stake?

Let’s put the issue in perspective. U.S. tax revenues currently run about $3 trillion a year. Of that, about $300 billion, or 10%, comes from corporate tax.

Estimates of U.S. tax revenue that would be lost if inversions continue unchecked run to about $2 billion a year. Even if that may be an underestimate, we are looking at a mere drop in the bucket.

Aside from tax revenue, there are other reasons the U.S. should wish corporations to keep their headquarters here. When corporations move their head office overseas, it reduces U.S. power and prestige. In addition, I believe that once a company has exported its headquarters, it is more likely to export jobs as well.

The King Canute conundrum

Mr. Obama and Mr. Lew can take steps to discourage inversions, but so long as the U.S. imposes tax burdens not levied by others, their efforts will meet with limited success. It will be almost like King Canute commanding the sea not to advance.

The U.S. should switch to prevailing practice and adopt the principle of taxing earnings where they are made.

The loss to the U.S. Treasury could be counteracted by offsetting tax increases, such as raising the corporate tax rate. Or eliminate some corporate deductions and tax privileges — of which the U.S. has many.

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