The Pfizer World Headquarters is in Manhattan. The U.S. drug giant says it is moving its headquarters to Ireland, where taxes are much lower.CARLO ALLEGRI/Reuters
'Disgusting," snorted Donald Trump after U.S. drug giant Pfizer said it was merging with Botox maker Allergan and moving its headquarters to Ireland, where taxes are much lower.
The Republican presidential front-runner isn't alone in his bluster.
Inversions, as these tax-driven corporate deals are known, have become a favourite target of U.S. politicians of all stripes. Democratic hopeful Hillary Clinton similarly accused Pfizer, whose drug cabinet includes Viagra and Lipitor, of exploiting tax "loopholes" to avoid paying its fair share.
But the United States has avoided the one obvious move that would stem the flight of multinationals: bring its corporate tax rate into line with the rest of the developed world's.
U.S. companies face a 35-per-cent federal tax rate – the highest in the developed world. In Ireland, the rate is 12.5 per cent; Canada, 15 per cent.
For the past four years, Congress and the White House have dithered about overhauling the U.S. corporate tax code, in spite of broad agreement that it's the right thing to do. It has become easier to blame companies for behaving rationally and legally, than to fix the system. And the United States is living with the consequences.
Unlike Canada and many other OECD countries, the U.S. applies its corporate tax to income earned anywhere in the world, granting only part credit for taxes paid to foreign governments. And because companies generally aren't taxed until they bring their profits back to the U.S., they have a perverse incentive to keep profits offshore in the lower-tax country, sometimes indefinitely. U.S. companies now have more than $2-trillion (U.S.) stashed in other countries.
Like Pfizer, dozens of prominent U.S. companies have gone a step further by moving their tax address right out of the country, including Medtronic, Fruit of the Loom, and Ingersoll-Rand. And last year, Burger King merged with Canada's Tim Hortons Inc., relocating the parent company's head office to Oakville, Ont.
The average federal and state tax rate on U.S. companies is about 40 per cent. The comparable federal-provincial rate in Canada is roughly 26 per cent.
Few U.S. companies pay the posted tax rate, thanks to a raft of loopholes and exemptions. But there is still a significant tax gap between the U.S. and virtually every OECD country. Pfizer, for example, has indicated that moving to Ireland will lower its overall tax rate to roughly 17 per cent from 25 per cent now.
Pfizer is hardly pulling up stakes. The company says it will still have 40,000 employees across 25 states – all paying income tax, one presumes. And some of the money its saves on corporate taxes will be poured back into "significant" investments in the U.S., Pfizer says.
The larger issue for the U.S. is that corporate taxes probably aren't the best way to achieve tax fairness and economic efficiency.
Sticking big companies with hefty tax tabs is politically popular, but economically dubious. Echoing many economists, the OECD Secretariat argued in a 2010 report that governments seeking revenue should look to consumption and property, not companies.
"Corporate income taxes are the most harmful for growth as they discourage the activities of firms that are most important for growth: investment in capital and productivity improvements," concluded the 157-page report, titled Tax Policy Reform and Economic Growth.
The U.S. tax regime is upside down. It is the only major developed country without a national sales tax. Forty-five U.S. states have statewide sales taxes, but these tend to be relatively low, with none higher than 10 per cent. The U.S. generates a smaller proportion of revenue from consumption taxes than all other wealthy countries – 15 per cent of tax revenue versus the OECD average of 31 per cent.
The downside of consumption taxes is that they are regressive. Unlike income taxes, poorer people pay the same rate as the 1 per cent. But this problem is easily fixable by providing support directly to those who need it most.
The sensible thing for the U.S. to do is lower the corporate tax rate, lighten the tax burden on foreign income, and pare down the vast array of loopholes. If there is any loss of revenue, the U.S. could impose a national sales tax, as does Canada and most other OECD countries.
Mr. Trump and the others should stop haranguing and embrace tax reform.