Again, a U.S.-based multinational corporation is merging with a foreign counterpart, with the intent to pay taxes at the other country’s lower rate. By joining forces with Ireland-based Allergan, pharmaceutical maker Pfizer may reduce its effective tax rate from 26 percent to 17 percent. And once again, U.S. politicians are denouncing the deal as a demonstration of corporate America’s allegiance to profits above its responsibility to help pay for the government that enforces patent rights, among other beneficial services. Last year, Congress’s Joint Committee on Taxation projected that all such tax-driven mergers, known as “inversions,” would erode federal revenue to the tune of $33.6 billion over the next decade.
The denunciations are not wrong; it is galling to see a company such as Pfizer, established in Brooklyn way back in 1849, abandon its home country — even if its actual operations may mostly stay put, and even if its new address is in many ways a legal fiction. However, as in previous iterations of the debate over such tax-driven inversions, it is unrealistic to expect multinational firms to follow patriotism rather than their bottom-line interests, given the U.S. corporate tax rate of 35 percent, the highest among major developed nations — and, given that, also uniquely, the United States tries to apply that rate to all global income. (Like many companies, Pfizer pays less than the top rate thanks to deductions and other tax-reducing strategies.)
Without an act of Congress, preventing inversions is next to impossible. Indeed, the Pfizer-Allergan deal is happening more than a year after the Obama administration announced new anti-inversion rules; those called for the non-U. S. company to constitute at least 40 percent of the value of the newly merged company, so the firms structured the transaction to keep Allergan’s share at 44 percent. This is roughly what Prof. Mihir Desai of Harvard University predicted in congressional testimony at the time.
The problem here is not multinational mergers per se; they can be beneficial when done in response to opportunities for more efficient production and distribution. The problem is mergers driven by tax considerations rather than economic fundamentals. In this sense, tax inversions are emblematic of the broader U.S. tax code, which too often rewards system-gaming over productive activity. Imposing new rules piecemeal isn’t the answer, nor is sending U.S. corporate executives to patriotic re-education camps. Instead, Congress should reform tax laws to better align private-sector incentives with national interests.
Broadly speaking, the reform formula involves lower rates applied to a broader tax base. In this case, that would mean reducing the U.S. corporate tax rate to a level more in keeping with the 24.1 percent average among advanced industrial countries, while eliminating loopholes and shifting the focus of taxation to the people who actually own companies: shareholders. Individuals can’t “reflag,” so it may be more efficient to tax their dividends than to chase corporate income all over the planet. There’s no way to force U.S. companies to stay home if the tax incentives to leave are overwhelming. The goal should be to make it worth their while to stay.
FROM AN EDITORIAL IN THE WASHINGTON POST