Unfortunately, America’s high road to fiscal responsibility has taken a detour. The supply side notion of keeping tax rates at reasonable levels while reigning in government spending has clearly been a central issue in US politics, but lack of constructive corporate tax reform conspicuously misses the mark.

In early 2013, opposing political parties, under the lash of a massive economic fallout scenario, worked out a bipartisan deal to avert the so-called ‘fiscal cliff’ dilemma. The last minute compromise, reached on New Year’s Day of that year, indefinitely extended marginal tax rates on annual family incomes up to $450,000 while only modestly lifting the top capital gains and dividend tax rates from 15 percent to 20 percent.

Although the 2013 legislation helped American citizens minimise the impact of government largesse at the personal level, the same type of bipartisan solution remains elusive with respect to corporate tax legislation. Interestingly, both Democrats and Republicans agree that the corporate scheme needs a refresh, but both sides are unwilling to bridge the gap required to knock out an effective solution.

The latest political showdown is occurring over so-called ‘tax inversions’ whereby global companies headquartered in the US attempt to acquire companies in foreign jurisdictions in order to move their domiciles to nations with lower tax rates. Effectively, America’s high corporate tax rates are chasing jobs overseas and preventing large amounts of cash held in foreign accounts from being repatriated. When lawmakers become irrational, companies often vote with their feet and leave.

America’s 35 percent top tax rate is the highest among the 34 members of the OECD. Countries such as the UK and Ireland charge much less and are happy to collect revenues resulting from inversions. In fact, up until about a decade ago, ‘tax haven’ status countries such as Bermuda and the Cayman Islands with no explicit corporate tax were preferred destinations. But then American legislators made it a requirement that at least 20 percent of a merged company be controlled by non-US investors, sending acquirers to larger jurisdictions.

According to the Congressional Research Service, approximately 47 US firms reincorporated overseas via inversions during the last ten years, which is more than in the previous two decades combined. Since the tax haven plan was knocked out, Ireland and the United Kingdom have been leading beneficiaries of the 80/20 standard with top tax rates of just 12.5 percent and 21 percent, respectively. What the Standard & Poor’s rating agency referred to as the ‘dysfunctional policymaking in Washington’ when they downgraded America’s debt rating in 2011 has been a revenue boon for other countries.

Lately medical companies have led the pack in inversion strategies. Pharmaceutical company, Abbvie Inc, had been attempting to buy Dublin-based rival Shire Plc while Medtronic, the world’s largest medical device manufacturer, is going after Covidien Plc, also headquartered in Ireland. Earlier this year, Pfizer, Inc. made an unsuccessful run at British drug giant, AstraZenica Plc.

For those companies in the midst of negotiating cross border deals, the clock is ticking on some transactions. In late September, US Treasury Secretary Jacob Lew announced the Department was using five sections of the US tax code to launch an assault on inversions by taking away some of the tax benefits. The agency is trying to make it more difficult for companies to access their overseas cash without having it taxed at US rates while tightened standards for a merger to qualify as an inversion. Stocks involved in inversion deals took a hit on the news and eight US companies with pending deals must now decide whether or not to proceed. Last week, Shire Plc’s stock tumbled 30 percent in one day on news that Abbvie Inc was on the verge of abandoning its takeover attempt after talks with the US Treasury Department and Internal Revenue Service left it convinced that tax-rule changes would undermine the transaction’s rationale.

While both Republicans and Democrats would like to see lower corporate taxes, a compromise is not yet in sight. Economist magazine recently suggested that both sides are unable to come to terms: “Barack Obama has proposed a reform that cuts the rate to 28 percent but keeps the worldwide reach. Dave Camp, a Republican congressman, has plumped for 25 percent, the OECD average, and a shift to a territorial system, instead.” Personally, I find it quite disturbing that a leader would attempt to tie a tax reduction with a spending increase, automatically taking the county further into debt.

Having the two main political parties at an impasse is a result of the wide canyon of philosophical difference. The Democrats would like to see more spending tied to a tax cut while Republicans favour further reductions in personal income tax rates. Thus, nothing has been done and the default solution is an attempt at taking global companies hostage with tougher tax rules while Congress and the Senate remain on hold awaiting the November 4th midterm election results.

As the countdown to Election Day approaches, the GOP looks to have a good shot at creating a new balance of power in Washington. A recent Wall Street Journal article stated: “Republicans hold a clear edge as the midterm campaign heads into its stretch run. The party is almost certain to keep control of the House, and may expand its majority to the Senate.” However, the WSJ also reported that the imminent change in leadership is more a result of disenchantment with the current representatives rather than enthusiasm about new candidates: “two-thirds of registered voters believe the country is on the wrong track, while just a quarter say the US is moving in the right direction — the widest gap before a midterm election in more than 20 years.”

While the issues surrounding corporate tax inversions are only a small part of the platforms being debated, America’s political system clearly needs to restore confidence. New leadership will be challenged to find the common ground needed to move economic progress forward. Addressing the corporate tax scheme without attaching it to other agendas would be a step in the right direction.

Bryan Dooley, CFA is a senior portfolio manager at LOM Asset Management Ltd in Bermuda. Please contact LOM at 441-292-5000 for further information.

This communication is for information purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, investment product or service. Readers should consult with their Brokers if such information and or opinions would be in their best interest when making investment decisions. LOM is licensed to conduct investment business by the Bermuda Monetary Authority.