(User epSos.de, Flickr Commons) Corporate inversion, the legal process by which U.S. companies move their tax residence to foreign countries in order to reduce U.S. tax charges, have recently become the subject of significant media and political attention and scrutiny. The latest example appears in President Obama’s Fiscal Year 2016 budget, which proposes new rules to limit inversion activity. This follows recent restrictions imposed by the U.S. Treasury and IRS, as well as a series of bills sponsored in Congress aimed at preventing corporate inversion activity, including the Stop Corporate Inversions Act of 2014.

The bipartisan consensus appears to be that corporate inversion activity should be prevented or, at the very least, restricted. But is going after corporate inversion tackling the symptoms rather than the cause? What might be the wider economic impact of such restrictions?

Corporate inversions involve a U.S. company merging with a foreign company and relocating the tax residence of the merged company within the foreign jurisdiction. This enables U.S. companies to save substantial amounts in U.S. taxes both on accrued offshore cash piles and future profits. Companies practice corporate inversion largely because of the manner in which the United States taxes corporate profit. In an approach that is fairly unique in the modern world, the United States operates a worldwide system of taxation in which profits generated by a U.S. company outside of the United States are still subject to U.S. tax when repatriated. By contrast, many other countries tax businesses on a territorial basis, under which profits generated by foreign activities are taxed only in those foreign jurisdictions rather than in the company’s home country. In addition to its unique taxation system, the United States maintains, at 35 percent, one of the highest corporate tax rates in the world. Consequently, U.S. companies are strongly incentivized not to repatriate foreign profits. This has directly resulted in U.S. companies holding an estimated $2 trillion in revenue outside the United States.

However, deferring U.S. taxes by holding foreign profits outside the country is not a permanent solution. Ultimately, if this profit cannot be utilized for business purposes in foreign countries, it will need to be repatriated and either paid to shareholders or reinvested in U.S. operations—triggering high U.S. tax charges in both cases. This reality has driven many companies to pursue corporate tax inversions. Once inverted and under foreign ownership, accrued foreign profits can be paid up to the foreign parent, and ultimately its shareholders, in a number of different ways that avoid profit-repatriation. In addition, the inverted company can be restructured to ensure that future foreign profits flow directly to the foreign parent. As a result, the foreign profits generated by these companies are exempt from U.S. corporate tax.

In 2004, Congress passed legislation to prevent corporate inversions. Under this legislation, if over 80 percent of the shareholders of the foreign parent were previously shareholders of the U.S. parent company, the benefits of inversion are removed. Tax charges were also imposed for certain cases in which that percentage lies between 60 and 80 percent. This legislation was successful at preventing purely tax-motivated inversions, but the tax benefits of inversions remained available for mergers below the 80 percent shareholder threshold. Additionally, companies with substantial foreign economic activity beyond merger and acquisition still benefitted from a further specific exemption.

These conditions, coupled with the sheer amount of cash trapped outside the United States, have led to a series of high-value, high-profile corporate mergers in recent years that have involved or ultimately resulted in a shift of tax residence from the United States. Examples of such mergers include the merger of Burger King and Tim Hortons (to Canada), Medtronic and Covidien (to Ireland), and Liberty Global and Virgin Media (to the United Kingdom).

Despite past bipartisan consensus among both Democrats and Republicans that inversions need to be further regulated, strong differences of opinion have surfaced between the parties about how this issue should be addressed. As demonstrated by President Obama’s FY16 budget, most Democrats desire targeted legislation to specifically prevent inversion transactions. Republicans, meanwhile, generally prefer broader changes to those facets of the U.S. corporate tax system that are driving this behavior. With such differences in approach on both sides of the aisle, and with Republicans controlling both chambers of Congress, it is difficult to envisage a legislative solution to the issue of inversions coming about in the near future.

An important question that is not yet being addressed, however, is whether restrictions on inversion activity are effective in the first place. Without more fundamental changes to the U.S. tax system, it is likely that U.S. multinational companies will continue to retain profits outside the United States even if legislation intended to restrict or prevent inversion activity is implemented. This continued corporate behavior generates no additional U.S. tax revenue and prevents the return of such profits to shareholders. In many cases, these shareholders are ordinary U.S. citizens who have invested in large pension and investment funds. Investment in the United States is also likely to be detrimentally affected, as U.S. companies may continue to prefer investment and growth opportunities outside the United States that do not trigger U.S tax charges. As such, U.S. taxation on repatriated profits remains a disincentive for investors and corporations.

In the meantime, the rest of the world benefits from the current political and legal deadlock on U.S. corporate inversions. Adverse political and media attention, coupled with recent announcements on inversions by the IRS and U.S. Treasury, have dampened inversion activity. The result has been that U.S. companies will need to deploy trapped cash on expansion and growth outside of the United States. At the same time, it is still possible to invert and, in the right circumstances, remains beneficial for a U.S. company to do so. This means that inversion activity will potentially continue—with the jurisdiction of the merged company reaping the economic benefits such activity brings.

The best solution to the problem is also the most difficult. If the United States were to implement a territorial system of taxation and/or reduce its high corporate tax rate, the incentives for U.S. companies to invert would be removed or significantly reduced. It is difficult to see how any solution that does not remove the incentive for U.S. companies to retain profits outside of the country would ultimately benefit the United States. However, in the current political climate, it is equally difficult to see how the broad political consensus required to implement such a fundamental change to the U.S. corporate tax system could be achieved in the short term. As a consequence, corporate inversions are likely to continue to be a live issue for some time. But neither tax codes nor partisanship should prevent them from being seen for what they are—a symptom of the wider problem of a U.S. corporate tax system that seems increasingly outdated in today’s world.