Yet another big American company is fleeing overseas to find a safe space from U.S. taxes. And once again, grandstanding politicians are stomping all over the businessmen behind the deal.
Drug giant Pfizer, based in New York, is merging with Irish pharmaceutical firm Allergan in a $160 billion deal. If approved by regulators, this would be the largest "corporate inversion" to date, a clever bit of financial engineering where a company merges with a foreign rival based in a country with lighter taxes. The Pfizer-Allergan combo would be based in Dublin, reportedly cutting Pfizer's tax rate from 25 percent to roughly 17 or 18 percent. The new firm would still be called Pfizer, and would trade on the New York Stock Exchange under Pfizer's ticker symbol, PFE. But Pfizer's tax bill would be a heck of a lot lower.
The leading presidential candidates of each party are not happy about this. They dispute that what's good for Pfizer is good for America. Democratic frontrunner Hillary Clinton attacked Pfizer for avoiding its "fair share" of taxes in a deal that "will leave U.S. taxpayers holding the bag." Republican frontrunner Donald Trump called the very idea of inversion "disgusting," and said Washington "should be ashamed" for allowing it.
All wrong. Even if you oppose this controversial tax strategy, each time it happens — with more and more tax revenue disappearing — pressure increases on Washington to reform the broken U.S. corporate tax code.
The U.S. has an uncompetitive corporate tax code — including high statutory and effective tax rates. Forcing U.S.-based firms to deal with this leaves them at a global disadvantage. New rules to discourage inversions might also create harmful distortions. For instance: Disallowing the technique if a company leaves a certain share of management in the U.S. might only prompt them to move those high-paying jobs overseas and make them less productive.
Lowering the corporate tax rate and only applying it to domestic earnings has merit. There is, however, a risk that companies will attempt to game the system and make domestic profits appear to have been earned elsewhere. In addition, outsourcing and global supply chains sometimes create an arbitrariness about deciding in which country profits should be booked.
The corporate tax reform process doesn't seem to be making much headway — even though both parties agree that the top 35 percent federal rate should come down. But if anything, the two sides are drifting further away from each other, as progressives like Elizabeth Warren argue corporations pay too little in taxes. Meanwhile, companies that benefit from existing tax breaks continue to fight for the status quo.
Sidestepping the current debate with more radical reform might be the best option. Instead of taxing companies based on where they are officially based, tax American shareholders at regular income tax rates on their gains, even those that just accrue on paper. Economists tend to agree that corporate taxes are economically inefficient, with some portion borne by workers. Another option would be to replace the corporate income tax with a broad consumption tax, as Ted Cruz recently suggested. In either case, richer Americans might need to pay higher taxes in some form to keep from increasing the budget deficit. (Cruz did not suggest that.)
The need here is so obvious that reform shouldn't be so hard. But it is.
Every time a big company leaves, the push for reform probably gets just a bit easier. And in that sense, we might owe these "Benedict Arnold" CEOS a thank you.