Can Obama slow corporate inversions? Yes he can.

Politicians can debate whether corporate tax inversions are “unpatriotic” or simply a legitimate technique to reduce taxes–and commentators can argue over whether anything should be done to stop them. Experts also disagree about whether President Obama and his Treasury Secretary have the legal authority to write new rules to discourage inversions. In my view, on this last question, the law clearly provides Treasury that authority.

After a U.S. corporation inverts, a foreign company owns it (rather than it owning the foreign company). The U.S. corporation is still subject to U.S. taxes, but it can reduce its tax liability by borrowing large amounts from its foreign parent, and deducting the interest payments against its earnings. (If, without inverting, the U.S. corporation borrowed from a foreign subsidiary, it might defer, but it could not eliminate, the tax on its earnings; it might also trip other rules, like the tax on repatriated earnings.)

Treasury Secretary Jack Lew can use many different tools to stop this game. For example, in 1969, Congress enacted Section 385 of the Code, which authorizes him “to prescribe such regulations as may be necessary or appropriate to determine whether an interest in a corporation is to be treated for purposes of this title as stock or indebtedness.” In other words, in appropriate circumstances, the Secretary may write rules to treat interests in a corporation as equity rather than debt. This matters because payments on equity (i.e., dividends) are not deductible and thus do not lower a corporation’s tax bill.   Thus, the interest payments to the foreign parent would no longer be deductible, which would remove virtually all of the appeal of such “earnings stripping” transactions.

Harvard Professor Stephen Shay first pointed out this authority–and several other sources of authority–to urge Lew to stem the flight of U.S. corporations (and their tax dollars). If Treasury acts, U.S. corporations could still flee—but they could not load up on debt afterwards to eliminate their future tax liabilities.

The U.S. Supreme Court has made clear the scope of legal authority for an agency that has been granted regulatory authority by Congress: “If Congress has explicitly left a gap for the agency to fill, there is an express delegation of authority to the agency to elucidate a specific provision of the statute by regulation. Such legislative regulations are given controlling weight unless they are arbitrary, capricious, or manifestly contrary to the statute.” Regulations are subject to the “notice and comment” procedures of the Administrative Procedure Act, but properly created, have the full force and effect of law.

Here, Congress explicitly gave Treasury wide authority to treat interests in corporations as equity, not debt. So, writing rules that treat obligations that are issued by a U.S. corporation to a foreign affiliate as equity would hardly contravene Congress’ authorization. They could readily be written in a way that was not arbitrary and capricious. And Congress expressly asked Treasury to separate equity from debt without regard to Congress’ other efforts to limit interest deductions.

Admittedly, Treasury’s track record in writing regulations under section 385 is not great. In March 1981, Treasury proposed regulations under section 385, and finalized them 11 months later. Less than two years later, however, Treasury withdrew the regulations in the face of widespread criticism of their inflexible tests.

Treasury should try again. But, this time, it should focus on obligations issued by U.S. corporations to foreign affiliates. These rules might be limited, initially, to obligations to foreign affiliates in inverted groups but, eventually, to foreign affiliates in any group. Treasury’s authority is not diminished by the age of the statute—or the agency’s past efforts. So, while policy and political considerations may determine the administration’s course of action, Treasury could readily end a practice that threatens to undermine the U.S. corporate tax base.