Effective Tax Rate Changes and Earnings Stripping Following Corporate Inversion‪.‬

INTRODUCTION In a typical corporate inversion, a U.S.-domiciled parent corporation forms a new subsidiary in a tax haven country, and the haven-domiciled entity becomes the parent company of the firm's U.S. and foreign operations. Executives of inverting firms typically state that inversion will reduce the financial statement effective tax rate (ETR) and improve earnings and cash flows. (1) While acknowledging the legality of inversion transactions, policymakers have questioned their ethics and patriotism. Senator Charles E. Grassley describes inversion as "immoral," and states that "during a war on terrorism, coming out of a recession, everyone ought to be pulling together. If companies don't have their hearts in America, they ought to get out" (Hamilton, 2002). However, an Ernst & Young promotional video asserts that "just the improvement on earnings is powerful enough to say that maybe the patriotism issue needs to take a back seat to that" (Hamilton, 2002). Managers suggest that the source of inversion-related tax savings will be the reduction or elimination of U.S. tax on foreign-source earnings. For example, at a May 14, 2002 special meeting of shareholders, Cooper Industries' CEO H. John Riley, Jr. stated: