No choice - higher taxes pushing US companies to decamp to safe-havens

Monday, May 12, 2014

By Farrokh Langdana, Director, Executive MBA Program & Professor of
Finance and Economics

Faculty Blog:

US Tax Code

"Inversion" is the process by which large domestic companies decamp for lower tax rates in safe-haven countries such as The Netherlands, the UK and Ireland. Witness US-based Pfizer's $100 billion attempt last week (April 28, 2014), to buy UK-based AstraZeneca (AZ). Pfizer (originated in Brooklyn, NY), pays an effective tax rate of 27.4% in the US, while AZ pays 21.35%, which translates to over $1 billion dollars in tax savings for Pfizer per year. US companies must transfer at least 20% of their shares to foreign ownership to decamp.

From a macroeconomic perspective, it makes plain sense to decamp. As tax increases shove the aggregate demand curve to the left and contract the economy/sector, the 'size of the pie' falls. In this context higher tax rates are simply attempts to obtain "larger slices of shrinking pies."

Straight out of macro class: T = tY where T is tax revenues ($), t is the tax rate (%), and Y is national (or sector-specific) income ($).  So if the tax rate, t (the slice of the pie), increases, and Y (the size of the pie) falls, the effect on tax revenues, T, is ambiguous.  In our discussion here, tax revenues, T could fall.

And as more and more companies flee, we may actually end up with lower tax revenues in the pharmaceutical industry. Examples abound:  Michigan-based Perrigo Co., bought low-tax-based Elan Corp.  Actavis inverted by buying Dublin-based Warner Chilcott.  And Pennsylvania-based Endo Health teamed up with Canadian Paladin Labs to "resurface" in Ireland where the corporate tax rate is as low as 12.5%!  

It is not just pharma:  Chiquita Brands and the music group U2 have both inverted to Ireland, as is Walgreen in the UK after teaming up with the British pharmacy, Alliance Boots.

UK Tough on Taxes

Is this a responsible strategy by companies? Should companies 'up and move' constantly to the next lower tax destination?  Before we gang up on corporate America again, it’s not just high taxes that are driving US companies overseas, but also the plethora of new and increasing levels of stifling regulation that have cramped "business speed" in the US. The response of short-sighted policy makers following Enron and the "Housing Crisis" was to regulate the economy even more.  Those familiar with Daoism in China from thousands of years ago will know, the moment you try to build a 50-foot wall to restrict activity, someone will invent a 51-foot ladder to overcome Ireland, the UK and The Netherlands.

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