Message and Messenger

May 19, 2014 --

Single events sometimes crystalize broader issues. Thus the loud and pointed debate across the Atlantic about U.S.-headquartered Pfizer’s $100 billion-plus bid for U.K.-headquartered Astra-Zeneca. In London Prime Minister Cameron is pondering whether to intervene in the wake of Pfizer CEO Ian Read’s testimony before the British Parliament on how this deal would impact U.K. innovation, jobs, and overall economic competitiveness.

In Washington many in Congress are ruing these “corporate inversions,” in which a U.S.-headquartered company becomes a foreign-headquartered company through an M&A transaction and thus “inverts” its citizenship. Dozens of such M&A-linked inversions have happened in the past year or are being discussed (even by the iconic U.S. retailer Walgreens), and in response many are blaming the companies. In announcing plans to introduce legislation banning companies from inverting, Senator Carl Levin intoned, “It’s become increasingly clear that a loophole in our tax laws allowing these inversions threatens to devastate federal tax receipts.”

Thus is the issue laid bare. Are U.S. leaders going to heed the sobering policy message being delivered to them by Pfizer and others: that America’s current system of business taxation is penalizing U.S.-headquartered companies seeking to compete in world markets—and thus to support jobs and investment in America? Or are U.S. leaders going to shoot the messenger?

To explain this message, here is one of those precious pictures worth a thousand words.

For each of the 34 members of the Organization for Economic Cooperation and Development, this picture reports its 2013 federal statutory corporate tax rate. Countries with a tax rate indicated by a blue bar operate what are commonly referred to as territorial tax systems; that is, these countries exempt from taxation any foreign-affiliate earnings for multinational companies headquartered in them. Countries with a tax rate indicated by a red bar operate what are commonly referred to as worldwide tax systems; that is, these countries impose a tax liability on any foreign-affiliate earnings for multinational companies headquartered in them.

This picture conveys two stark realities about the uncompetitive tax burdens facing U.S.-headquartered multinational companies. One is their high statutory corporate tax rate: at 35 percent, it is today the highest such tax rate of any of the 34 OECD members. The other is the added complexity of facing worldwide rather than territorial taxation.  The United States is only one of seven OECD countries whose corporate-tax regime is worldwide rather than territorial. Most of these other worldwide countries have much lower marginal tax rates—e.g., Ireland at just 12.5 percent. And, most of them are much smaller countries than the United States, and thus are not home to many of the world’s biggest multinationals against which U.S.-based companies compete.

This combination of a high-rate, high-complexity U.S. tax regime is arguably the worst in the OECD—and well beyond—for supporting the global competitiveness of U.S. companies.  Consider a U.S.-headquartered multinational competing in world markets against another multinational headquartered in a territorial country.  If those two companies earn the same pre-tax income in a third market, then the U.S. company faces a large home-country tax liability that its foreign competitor does not (even with, if you know what this means, acknowledging the various deferral rules in current U.S. tax policy).

In turn, smaller after-tax worldwide earnings for American companies means a reduced ability for American companies to hire workers, invest in capital, fund new innovations in America and elsewhere—i.e., to do all the dynamic things that drive growth in output, incomes, and, ultimately, tax revenues. Mr. Read was correct to observe that a Pfizer-Astra Zeneca merger would “liberate the balance sheet and tax of the combined companies.”

America’s uniquely burdensome corporate-tax regime was not always so. When America lowered its corporate tax rate as part of its last major tax reform in 1986, the U.S. statutory corporate tax rate was several percentage points below the OECD average. In the 28 years since, literally dozens of countries around the world have radically reformed their tax regimes—generally by cutting their tax rates and also by simplifying their overall systems, which in many cases involved switching from worldwide to territorial.  If anything, the pace of worldwide tax reform seems to be accelerating, not slowing.

Thus the question for America’s leaders. Like it or not, Pfizer and dozens of other U.S. companies are sending a clear message. The country’s uncompetitive tax regime is eroding the country’s ability to create and maintain the jobs and investments needed to succeed in today’s global economy. Will leaders heed this message? Or will they just shoot the messenger?

Articles © 2014 Matthew Slaughter and Matthew Rees. All rights reserved.
Publication © 2014 Trustees of Dartmouth College. All rights reserved.