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The Treasury Wins Over Pfizer. Of Course.

So the Pfizer-Allergan deal has collapsed. The two companys are walking away from it, since under the new rules announced by the Treasury Department, there would be no tax advantages. And this one was all about the taxes – there was no particular drug development or business rationale other than saving a big bucket on taxes while being able to redeploy the company’s foreign earnings. There was really no point in trying to rework the terms of the merger, since the government would have countered with new rules to block whatever Pfizer might have come up with.

How you feel about this depends on your pre-existing point of view. My own feelings are mixed – on one side of the issue, I have absolutely no desire to see Pfizer do yet another mega-merger. I think that their merger history has been bad for the industry, certainly bad for a lot of former employees, and probably bad for Pfizer shareholders as well. On the other hand, I’m not so happy to see the coercive power of the state deployed so blatantly. The government’s behavior strikes me as akin to Calvinball; the rules will change to be whatever it takes for the government to win. Commenters who are marking this down as “a big win for the Obama administration” puzzle me – if you write the rules of the game, own the referee’s whistle, and are in charge of the scoreboard, you can get a big win any time you want. This wasn’t some hard-fought victory.

So all that Pfizer money that was earned overseas, and is sitting over there not being taxed under US corporate rates, will continue to sit over there not being taxed at US corporate rates, instead of moving to Ireland, where it would not be taxed by the US, either. I suppose that’s a win. What this does do is keep Pfizer’s future US earnings within the US, but if they were an Irish corporation, their US business income would be taxed at US rates, anyway. (There are other tax considerations, but that’s a big one).

What our tax structure does, in the end, is encourage US corporation with foreign branches to defer US taxation by keeping that money overseas. I realize that many US corporations actually pay a lower effective tax rate than the (high) US one, but that’s because they deliberately set themselves up to route as much income as possible through lower-tax countries – those lower effective rates are, in many cases, a symptom of the problem we’re talking about, not a refutation of it. People who are upset about domestic companies investing their money in other countries, rather than in the US itself, should look to the root cause of the problem: our tax code is something that the huge majority of large US companies take great pains to try to avoid, devoting time, money, and effort to this work that could presumably be used to do something more productive. And their overseas earnings, even when those could be used to do something productive in the US, will not be brought back here, because of our tax code.

This is particularly a problem for the US pharmaceutical industry, whose products are sold all over the world, but it affects the economy of the entire country. High-fiving each other over having rewritten the rules to perpetuate this system doesn’t seem appropriate to me, but whatever brings you happiness, I guess. In the same way that Donald Trump is one of the few people that could bring me to vote for Hillary Clinton, the US Treasury is one of the few organizations that can make me feel any sympathy at all for Pfizer. What a world!

51 comments on “The Treasury Wins Over Pfizer. Of Course.”

  1. anonao says:

    US has this particular system with money abroad, but it is delusional to think that companies are behaving nicely in other countries.
    If the tax was like other countries (like in Europe), they would the same and go to tax havens to store benefits (just need to see the recent panama papers to see that Europeans are doing the same to avoid tax).
    And as mentioned yesterday, Shire was found to pay only 2% tax rate in Ireland, and Apple is under scrutiny about their tax rate with the government, so even if US has a tax rate of 5% that would still be too high

  2. Hap says:

    If you’re a smaller business, though, you don’t get a choice as to what rate your income will be taxed – it’s taxed at whatever rate is set by the Treasury, or whatever rate your accountants think they can get away with. I don’t see any reason to feel sympathy for Pfizer for not being allowed to play by a different set of rules than other businesses.

    I also don’t see much reason to feel sympathy for all the businesses unwilling to pay the statutory rate on their incomes. They established here for a reason (other than being born here, which is initially dominant) – the infrastructure (philosophical, legal, and physical), people to work, and people with money to sell to. They knew those rules and chose to be here anyway because they had a chance at success. In succeeding, they then decide that those rules (the ones that helped them succeed) shouldn’t apply to them anymore. The government doesn’t appear to be the only one changing the rules of the game here.

  3. PorkPieHat says:

    Hap is totally right here. Businesses change the rules (lobbying) or bend the rules (high-priced lawyers) or some cases, outright break the rules (the fraudulent ones). Im no fan of big government, but lets not kid ourselves about the power of big business here and pretend that they cherubically follow the rules or play fair all the time.

  4. Morten G says:

    I’m going to use Starbucks as an example instead of various pharma – fewer worries about our job market interfering when we talk Starbucks. The points are valid for most big companies.

    I live in Europe and in most European countries Starbucks pays 0% tax on their profits. Their products are hit with a sales tax (in some countries) and their employees pay income tax. Now when confronted Starbucks answers that they pay no taxes because there are no profits. This is strictly true because the profits are moved out in a way to avoid being recognised legally as profits.

    If you are saying that Starbucks pays corporate taxes on their US profits and they would still do so if they somehow moved to Ireland then the US is obviously doing a much better job with their tax codes than the EU. Even if the US companies are accumulation lots of profits in off-shore holdings that money will eventually make it’s way into US bank accounts. So you are managing to have the stream of money head more into the US than out. Of course it’s at the expense of the world’s customers, employees, and infrastructure creators – not a long-term viable strategy but it might be a life-time viable strategy.

    1. Garrett Wollman says:

      It may be relevant here that one of the ways Starbucks et al. avoid taxes is Europe is by creative intellectual property licensing. By assigning their IPR to subsidiaries in low-tax countries, they can then charge high licensing fees to subsidiaries in higher-tax countries that actually provide the real product and/or service, ensuring that they are not profitable. This happens on the state level in the US as well (look up “Delaware Intellectual Property LLC”), or at least did until states got wise to the scam and made these sham intra-company licensing fees non-deductible. But that sort of arbitrage is what the US nationality-based tax system is allegedly supposed to suppress.

      1. Mike C says:

        Pharmas still do the same by selling their IP to foreign subs and by manufacturing in tax havens. E.g. Ringaskiddy, Ireland for Pfizer. This fight isn’t over foreign revenue, it’s about offshored US revenue.

  5. Postdoc Parasite says:

    That “coercive power of the state” also included my NIH pre- and post-doctoral training grants and guaranteed student loans.

    Just sayin’

  6. Argon says:

    Yes, the US should try to fix the corporate tax system. Too bad we’ve got lobbyists, an election funding system that requires representatives spend over 50% of their time on fundraising, and no chance of having a non-partisan panel of experts write rules that won’t be instantly perverted by amendments. Otherwise, it would be great!

    Meanwhile, we have states that have given decades-long, sweetheart tax and land deals to Pfizer (New London – eminent domain) and other companies to lure them in, only to be shafted later.

    ————————————————–
    I’m also not sure that I buy the underlying argument. I don’t know if companies are investing overseas to avoid taxes as much as to access cheaper labor. IT, chemistry and production in many markets have left the US (and other, older industrial nations) to reduce labor costs.

    Pfizer could easily have ‘invested’ overseas or truly have moved overseas, but they chose a scheme to shield their profits from taxes. Further, they wanted access to the cash so that they could get big enough to split into several companies and ‘unleash shareholder value’. ‘Investment’ had nothing to do with the deal, as we can see by how it failed when the tax shelter was blown away.

    *sigh* At least there are a few financial and consulting firms that won’t big getting big bonuses at the end of the year. So, that’s one silver lining.

  7. Good point about the rules being changed, and in this case the rule changes are very much akin to a Bill of Attainder.

    Bills of Attainder, so abused in England, were something the Founding Fathers found so abhorrent it is specifically forbidden in Article 1, Section 9 of the Constitution.

    This move by the Obama Administration is the same in spirit, although it is done through a weaselly “regulatory” rule change and not strictly a law.

    Nobody should consider this a good precedent. You could be next!

    1. Hap says:

      You already could have been next – people and smaller companies are unlikely to have a chance to evade the decisions of government and large businesses. The expectation that Pfizer having the right to evade such decisions would be a victory for principled, limited government is nonsensical.

    2. Mike C says:

      On the other hand, the IRS has always defined tax shelters as abusive if the transactions’ purpose is primarily to avoid taxes. Pfizer and Allergan pretty much just admitted that.

  8. Hap says:

    Maybe the Treasury should have said that Pfizer could pay Ireland’s taxes if they could have their payment structure as well. I’m guessing that wouldn’t have gone so well.

  9. roger says:

    Argon @ 9:24 am

    It is primarily compliance costs that companies seek to avoid not labor costs which prompts to moves overseas. If it is only labor costs you wish to decrease you can always find cheaper workers – outsource, contractors, fresh-outs, etc.

    1. Argon says:

      Roger, that’s a good point as well. I assume you’re describing tax compliance and not safety or environmental compliance. Still, you can’t pay someone in the US $24 for full day of labor doing assembly work. There are significantly different pay ‘floors’ in different countries. The wage differential is not all about compliance.

  10. Jim says:

    MPR had a great interview/panel with the former CEO of Medtronic (now at Harvard) and a law professor from Washington University (St. Louis). They bring some interesting perspective on what it means to be an American company or a multi-national company, and how dealing with tax codes all over the world is a fairly unique challenge. Worth a listen.

    http://www.mprnews.org/story/2016/03/31/tax-inversions

    1. Sam P says:

      Heck, there are probably has more than 10,000 sales tax jurisdictions in the US (there were 9,998 in 2014).

  11. A Nonny Mouse says:

    The US situation also problematic with individuals who live and work abroad; it is the only country (apart from Libya before it fell apart) where the people are subject to double taxation. No wonder the Facebook founder (living in Singapore) gave up his US citizenship.

    In the UK, our own mayor of London (born in US, dual nationality) was being forced to pay significant US taxes for Capital Gains when he sold his house at a profit even though it was not subject to tax in the UK (as primary residence).

    My wife worked on secondment in the US for a year and had to fill in US tax forms for the following 5 years!

  12. Hap says:

    I think people don’t feel that businesses have to play by the same rules as they do, or even big businesses versus smaller businesses (and since someone is going to have to pay for the things the inverted companies want but don’t have to pay for, the costs of tax inversions will probably fall mostly on smaller businesses and individuals). People would rather get nothing playing a game they feel is fair than get something in a game they feel is rigged against them.

  13. State of Nature says:

    The Calvinball analogy only holds if you picture Calvin as a self-harming schizophrenic. With the dysfunction in the legislative branch, it is a miracle that “Calvinball” can even be played…

  14. Curious Wavefunction says:

    Although I am not a big fan of government ‘coercion’ either, I do think this move on the part of the government will hopefully do some good in discouraging drug companies from spending all their time looking for tax loopholes and instead spend that time doing what they are supposed to do. Which is, oh I don’t know…discover new drugs?

    1. simpl says:

      Curious, I don’t think a conversion of accountants to researchers is likely to bring anything except frazzle. It is true that in our multinational company too, accountancy has been one of the big growth areas since 2000. However, this is less that they are digging for loopholes, these are brought in on a silver platter by the big four auditors/consultants. The new accountants are being embedded into each department, to comply with the more complex rules of corporate finance, which itself arose out of our interpretation of Sarbanes-Oxley.

      1. Ann O'Nymous says:

        The irony being that SOX exists because the previous generation of high-priced accountants utterly failed to detect fraud on an industrial scale. So we have people who used to work at Arthur Andersen getting paid $$$ because they screwed up royally when they actually worked there. Nice work if you can get it.

  15. Anon says:

    So much for “the deal makes sense even without the tax savings”. Clearly, avoiding tax and massive price hikes are the only things left driving “value” in this industry. Screwing tax payers, patients, payers and providers. That’s where the industry’s business model is right now that the R&D model is broken…

  16. ScientistSailor says:

    Derek,
    Trump-Hillary is an easy choice. What about Trump-Sanders?

    1. Anon says:

      Now we’re talking *really* hypothetical. May as well ask: “what happens when an unstoppable force meets an immovable object?” 🙂

    2. NMH says:

      I’m surprised Derek dislikes Hillary, in light of the fact she was one of the senators bought by PhARMA to vote for the Section D of Medicare, that cannot negotiate drug prices. PhARMA says jump, Hillary says “how high?”

      1. biff says:

        Derek can speak for himself, but he always has struck me as a principled libertarian, which is more or less my own political leaning.

        Just because a politician decides to put some money in my industry’s pocket one day (while taking it out of my pocket the next day) does not mean that I must support them as they bribe and extort their way to the next election.

        1. Docrailgun says:

          There’s no such thing as a principled libertarian – people who live in fantasy worlds don’t have them.

  17. John Doe-nut says:

    Continuing with Morten G’s Starbucks analogy, this latest example of the double standard that gets applied to large pharmaceutical companies is troubling to me as well. The fact that this type of government and consumer outrage over offshoring for tax purposes does not seem to gain any traction with other industries is yet another indication that this more about political grandstanding rather than anything of real substance. This has become commonplace with the tech giants, yet the fact that they sell us electronic gadgets and such makes them darlings rather than villains when they are the most egregious offenders with regard to taxation. Here are a few articles that cover this:

    http://www.theguardian.com/business/2015/jun/19/tax-havens-money-cayman-islands-jersey-offshore-accounts

    http://www.bloomberg.com/news/articles/2010-10-21/the-tax-haven-thats-saving-google-billions

    http://arstechnica.com/business/2015/10/apple-google-microsoft-hold-more-than-336b-overseas-via-legal-tax-loopholes/

    1. NJBiologist says:

      There’s also a double-standard in the response to international re-domiciling vs. reincorporation within the US. Many US companies have reincorporated in Delaware due to favorable tax/usury/other laws; we don’t seem to complain nearly as much about that.

      1. Hap says:

        I don’t know – it always bothered me about the banking/credit card merry-go-round (incorporating in the states with the most beneficial banking laws) – I thought ND was a favorite place for awhile, for example.

      2. Derek Freyberg says:

        Delaware is mostly favored for its corporate governance laws, not its taxation. It has simple and management-favorable corporate governance laws, and a court system that’s well experienced in dealing with them. Certainty is a real virtue if you’re wondering where to incorporate.

        1. NJBiologist says:

          Yeah, I kinda dashed that comment off in a hurry and conflated a few things. Delaware led the way by increasing the amount of interest a credit card issuer could legally charge, which brought in credit card issuers; I think changes in other laws followed, which Derek F points out. Then other states caught on (for example, North Dakota, as Hap notes).

          There has been some noise from politicians and the public, but not much, and nothing like what I’ve heard about pharma.

          1. Sam P says:

            No, Delaware’s Court of Chancery has been a feature for Delaware corporations for more than two centuries (est 1792, first in the US), well before credits cards.

          2. NJBiologist says:

            Sam P–The chancery court may have been there for centuries, but it was the 1981 reconfiguring of the usury law that brought Chase, Manufacturer’s Hanover and Chemical the same year.

          3. Sam P says:

            That may be why a number of big banks reregistered in Delaware, but that’s not likely why over 60% of the Fortune 500 and over 50% of all US publicly traded companies are Delaware corporations.

    2. Hap says:

      I assume that people don’t figure they have to buy Apple or Google’s stuff if they don’t want to and so aren’t as mad about their business practices, while drugs for the most part aren’t optional and so people have little say in the matter otherwise, The last few years of misdeeds and overselling by pharma have compromised its reputation badly, as well, and so allows people to hose it because they believe pharma is evil and whatever they do to it is OK.

      The tech industry seems hypocritical about a lot – they need the investment that gets them their workers and infrastructure but don’t want to pay for it (direct tax avoidance, also the “gray economy” business model (Uber, AirBnb) much of whose revenues come from tax and regulation avoidance and from which they are getting a significant, if not, majority cut of the profits) and they need lots of people to buy their stuff but don’t want to pay them (their even-more-massive-than-pharma outsourcing, need for lots of restricted visa holders).

  18. mdb says:

    One thing that most pro-government comments overlook is the “great” job the government did in keeping Pfizer’s profits off shore, will give many many start-ups something to think when choosing their location. The US long ago lost it’s edge with start ups, it still may be #1 overall, but per capita, it has fallen a lot. This will only aid that downfall. Bio-tech and pharma may take a while, as the US is still the biggest single market, but that market dominance will not last, and then what? I work in tech in pharma/bio-tech/r&d, I have seen 2 friends with green cards go home to start a business, it was an easy business decision, much harder personal one. The regulatory and tax environment in the US is terrible. They both sell products in the US without having to deal with the environment full time. The US is no longer the only choice, we can force companies to stay here, but you can’t force companies to start here.

    1. Hap says:

      1) What happens elsewhere when or if other countries can generate markets of their own? At some point, lots of the infrastructure the US has will need to be built elsewhere, and people will want clean air and water and schools. Where is that money going to come from? I am guessing that taxes and costs will go up, as well as regulation. Someone might find a less onerous way to achieve them, but human nature and bureaucracy being what it is, I wouldn’t bet much of my house on that.

      2) I think if you want to go somewhere else to start a business, that’s OK. It seems inconsistent, though, to start a business in a place with infrastructure and rules that help you and then decide when you win that you shouldn’t have to play by them anymore.

    1. Postdoc Parasite says:

      Thanks for the link. Despite her rabidly hypocritical hatred of everything/everybody Pharma (she cut her teeth in banking , M&A, and corporate consulting-Goldman Sachs and McKinsey, specifically) Yves Smith makes a great point here: “…the open question is whether Treasury intended its rule changes last year to be a warning shot, and the parties that should have gotten the message decided to ignore it…”

      This is one difference between failing with “thoughtful risk taking” at the lab bench and blusterous blundering in the boardroom. We don’t really need to speculate who will “OWN” this failure for the rest of 2016, do we?

  19. steve says:

    OMG!! You mean we actually have to produce some new drugs now!!!! No wonder there’s such a hue and cry to limit government.

  20. Levorotatory says:

    Why do we allow countries, states, and communities to manipulate their corporate tax rates to interfere with market forces?

    1. steve says:

      Market forces do not provide tax revenue. The idea that there should be no regulation and that companies should just be allowed to follow “market forces” is what led to the Savings and Loan scandals of the ’80s, Worldcom, Enron, Arthur Anderson, the Keating scandal of the ’80s and ’90s, Lehman Bros, the subprime mortgage scandals of the late 2000’s, etc, etc. No matter how many times this happens people always seem to ignore the lessons and call for deregulation and to just let companies follow “market forces” as though that’s an answer to the irresponsibility of management.

      1. Levorotatory says:

        I’m not saying no taxes and no regulation. I’m saying no tax rate manipulation by governments. Set a standard rate and hold it. This could be done by international trade treaties and national laws.

        1. steve says:

          That’s going to be very hard to do with the widely differing levels of social services offered by different countries. There is no way that a single universal tax rate will be suitable for all economic systems worldwide.

        2. RM says:

          The problem with a “standard rate” is that it’s still too nebulous to be useful. For example, “standard rate” of what, exactly?

          Gross income? Then you have a powerful force for vertical integration. If Pfizer buys something from an external supplier, that supplier has to report the purchase against gross income, which then gets taxed. This means there’s a powerful incentive to buy out the supplier such that the (now internal) material transfer doesn’t count as income. (So then is acquiring a supplier a tax dodge?)

          Okay, suppose you’re allowed to deduct manufacturing supplies (e.g. a VAT). Problem: what counts as a manufacturing supply? Does a single-use storage container? Does a multiple-use one? Does the construction of the manufacturing facility? Now you have a very complicated tax code, listing what is and is not a deduction.

          Okay, simplify it – all purchases are deducted. (e.g. a tax on net revenue). Sorry, you still have open questions. Does intellectual property transfer agreements count? Are salaries purchases of labor? (What if they’re contractors through an independent company instead of direct employees?)

          Fine! Tax net profits. Now you’ve opened up the floodgates to Hollywood accounting. Pfizer post a record year, and the CEO is raking it in hand over fist, but posts zero profits, due to a bunch of IP purchases it made (… and the aforementioned high CEO salary).

          Fact of the matter is, whatever corporation tax scheme you create is going to have loopholes, unintended side effects, and questionable grey areas. All tax codes are going to change the landscape of market forces by their very existence. There’s no magic bullet scheme. The best you can do is to come up with something reasonable, and then play wack-a-mole with people who are trying to dodge.

          1. Wile E. Coyote, Genius says:

            Actually, there is one really easy corporate tax code that has no loopholes. Make the corporate tax rate zero. Governments can rely on individual income tax for revenue. Corporate taxes account for less than a quarter of government revenue (at least in the US), so why not get rid of it? This also gets a lot of money out of politics, as there is then no incentive for corporations to lobby for preferential tax treatment. It also would allow all that overseas money right back in.

    2. Kaleberg says:

      Because we don’t want to be Somalia or some other place like that where market forces prevail. There are not a lot of pharma startups in Somalia.

  21. tangent says:

    Derek, you want to use this as an argument that U.S. corporate taxes are too high, a broken system, etc. It doesn’t actually support any argument about U.S. taxes themselves — the only thing it says anything about is the delta between taxes here and elsewhere. It could equally well be used as an argument that the U.S. ought to pressure other countries into raising their rates to match ours.

  22. Kaleberg says:

    It’s important not to forget that corporations are government chartered collectives. They rely on the government for their very existence. The reason the government issued them charters is that it found them useful, much as it finds having an army useful. Those charters grant them certain rights, but, unlike the rights of human citizens, those rights may be changed by the government. Didn’t Jefferson say something about rights being conferred by the creator? In the case of corporations, the creator is the government.

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