Pfizer recently offered $100 billion to acquire its rival AstraZeneca, headquartered in the United Kingdom. Currently operating out of New York, Pfizer is a biopharmaceutical giant with 2013 net earnings of approximately $22 billion, taxed at a rate of 27.4 percent. However, as evidenced by the exorbitant offer of acquisition, the U.S. firm is willing to go to great lengths to move its headquarters to the U.K. and minimize its tax liability, especially when the takeover would provide an estimated $1 billion in annual tax savings. If accepted, the Pfizer deal would serve as a quintessential example of a tax “inversion,” whereby a company and its substantial profits are moved offshore.
Such inversions have been commonplace with former U.S. corporations that preferred to increase shareholder wealth by pursuing lower tax rates offshore. As a result, the international Organization for Economic Cooperation and Development (OECD) has recognized that there are significantly less incentives for entrepreneurs and businesses to continue operating within the boundaries of the U.S. The OECD has even suggested numerous reforms to the U.S. tax system in order to alleviate the growing problem that serves as a widespread inhibitor within the integrated global economy.
The OECD has proposed that the U.S. marginal corporate income tax rate be significantly reduced to promote higher profit margins, and thereby produce incentives for corporations to maintain U.S. operations. U.S.-based firms would be less inclined to employ strategic inversions because the tax rate would be comparable to or lower than that of other nations. Because approximately 10 percent of federal tax revenue is derived from corporate income taxes, it is important that corporations do not transfer that significant burden to other U.S. taxpayers. Therefore, the OECD has also recommended that the U.S. broaden the tax base by phasing out the tax allowances currently available. By expanding the tax base, more individual tax revenue would counterbalance the slightly diminished corporate tax revenue.
As a result of such reforms, the OECD believes the U.S. would have a more attractive environment for entrepreneurial and corporate growth. This would ensure that the profits from large firms are redistributed throughout the U.S. economy rather than transferred offshore. Also, corporate inversions could impact domestic unemployment, serving as another detriment to U.S. households. Of the greatest concern to the OECD, such transferring of profits and tax revenues from the U.S. economy could unsettle domestic economic recovery and the associated international economic development.
Unfortunately, the current political standstill between Republicans and Democrats does not bode well for the reforms recommended by the OECD. The parties currently are having difficulty reaching agreements on less critical issues, so the possibility for agreement on a contentious, significant issue like tax reform seems unlikely, especially with the November elections approaching. As evidence of this, House Ways and Means Committee Chair Dave Camp’s (R-MI) broad-reaching tax reform proposal (released February 21, 2014) has yet to be considered seriously on Capitol Hill.
Given the stalemate in Washington, external pressure to act, like the OECD’s call for reform, may help to lead to some action. In fact, the OECD is not the only external party being encouraged to call for reform. Recently, Treasury Secretary Jacob Lew told business executives at the Economic Club of New York that their support was imperative to bring about tax reform.
Until it becomes either less difficult to pass new legislation or tax reform is treated with the utmost importance on the political agenda, a simple timeline can explain what is to come: 1) the U.S. tax base will continue to erode (meaning more tax inversions), which (2) will impair the U.S. economy and hinder global economic growth, and 3) then maybe eventually result in reactionary U.S. tax reform. Could U.S. government officials skip the second point in the aforementioned timeline through timely tax reform? In effect, the OECD simply proposes to the U.S. that the shortest distance between two points is a straight line.
Professor of Accounting