Inverted U.S. Tax Logic

Pfizer, the American pharmaceutical giant founded in a Brooklyn warehouse in 1849, came to such a point of frustration with the American tax system that the company concluded the most practical way of cutting through the madness was to leave the country altogether.

In 2014, it attempted to sell itself to AstraZeneca, a smaller British drug company, so that it could reincorporate in the United Kingdom to take advantage of its more favorable corporate tax rules.The deal was ultimately killed after British politicians threatened to block it.

But Pfizer finally got its wish this week to get out of America when it took over Allergan in a $160 billion deal.

Pfizer, maker of such drugs as Viagra, Lipitor and Celebrex, will now be able to establish itself in Ireland and enjoy the country’s 12.5 percent corporate tax rate. By comparison, the top U.S. marginal corporate tax rate is 39.1 percent — one of the highest in the developed world.

But while Pfizer is by far the largest U.S. company to have completed a so-called tax “inversion” — a corporate restructuring that gives a company a foreign status for tax-avoidance purposes — it is by no means an anomaly.

Between 1983 and 2003, 29 U.S. companies reincorporated abroad by inverting. From 2004 to 2013, there have been 47, according to Congressional Research Service. And this year alone, there have been at least 15 proposed inversion deals.

Earlier in 2015, Medtronic — the largest medical-device maker — took over the Irish company Covidien, while Mylan, another drug company, reincorporated in the Netherlands.

Between 1983 and 2003, 29 U.S. companies reincorporated abroad by inverting. 

The problem is not just stubbornly high U.S. rates and the country’s convoluted tax structure, but also its worldwide taxation scheme that taxes all corporate income earned abroad when it is brought back to the United States. U.S. companies have stashed an estimated $2.1 trillion overseas and kept it there to avoid paying taxes on it.

Most other countries, such as Ireland, have a “territorial” system that only taxes corporate income earned within its physical borders. By making itself an Irish firm, Pfizer can finally access the cash it has earned overseas without it being subject to U.S. taxation at the 35 percent federal rate.

By inverting, Pfizer estimates that it will decrease its effective tax rate from 25.5 percent to 17-18 percent, allowing it to save $21 billion on future tax bills.

Related: American Brands Go Foreign

Corporate inversions do not necessarily create job losses in the U.S. because they typically involve only a change in legal status rather than physical operating location. But they do have the effect of eroding the U.S. tax base. In 2014, congressional researchers estimated that nearly $20 billion in revenue would be lost over 10 years by companies inverting.

The flight of U.S. firms out of the country offers a startling indicator of how U.S. economic competitiveness is eroding. But rather than passing tax reforms that would create a more friendly and fair business environment, liberal politicians have resorted to the name and shame approach.

Hillary and her husband Bill have also exploited tax code loopholes in their favor.

Democratic presidential candidates Hillary Clinton and Sen. Bernie Sanders have accused Pfizer of exploiting legal loopholes to avoid paying its fair share of U.S. taxes and have called on President Obama to block the merger.

But Hillary and her husband Bill have also exploited tax code loopholes in their favor. Bloomberg reported in 2014 that the couple had created a network of residence trusts used to shelter certain assets, such as their home in Chappaqua, New York, from the estate tax. Hillary has campaigned in to past to expand the federal estate tax, and Bill vetoed a repeal of the tax in 2000 when he was still president.

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On the whole, the issue has been a major black eye for Democrats. Last year, Obama blasted such maneuvers as “unpatriotic” after Pfizer’s first attempt to invert. His words came back to bite him the following month when White House darling Warren Buffett — whose “Buffett Rule” had been a staple of Obama’s tax vocabulary on the 2012 campaign trail — embarrassed the president by financing an inversion of Burger King with Canada’s Tim Hortons.

The mass exodus of corporations doing inversions has given greater ammunition to Republicans, like Donald Trump, who say the country needs major tax reforms.

“The fact that Pfizer is leaving our country with a tremendous loss of jobs is disgusting,” Trump said on Monday. “Our politicians should be ashamed.”

Companies looking to invert argue that they are, in fact, doing their patriotic duty by relocating, arguing that lower tax bills equate to more money for research and development and more value to be returned to shareholders.

“It’s a great deal for the U.S., given that it frees up our ability to invest in American science,” Pfizer CEO Ian Read told the Financial Times.