3 December 2015

Corporate taxes stink, not Pfizer-Allergan deal

By Preston Cooper

For pharmaceutical giant Pfizer, the grass really is greener on the other side.

The American company recently announced plans to merge with Allergan, a smaller Irish company, a move that would allow it to relocate its corporate headquarters to Dublin. The $160 billion deal will allow Pfizer to avoid punitive American corporate taxes in favor of the much lower levies of the Emerald Isle.

The merger, structured as a much-derided “inversion,” has drawn criticism from proponents of high corporate taxes such as Democratic presidential candidate Hillary Clinton. She complained that companies like Pfizer “are leaving America to cut their taxes when they should be staying here and investing in the people and the opportunities that will build out economy.”

A look at the convoluted U.S. corporate tax regime shows that it’s hard to blame Pfizer for wanting to escape. America has the highest corporate tax rate in the developed world, at 39 percent when including an average of state levies. By contrast, Ireland has a corporate tax rate of just 12.5 percent. Pfizer is hardly the first American company to take refuge there—Apple has set up Irish subsidiaries to avoid American corporate taxes.

The high rate is not the only problem. America also taxes corporations on income earned anywhere in the world. Most countries, including Ireland, only tax businesses on income earned within their borders, to prevent double-taxation.

There was a time when higher rates did less damage, because other countries had comparable rates. But these other countries realized that such high taxes were bad for international competitiveness, so they cut them—by up to 75 percent  since 1984, in Ireland’s case. By contrast, the U.S. cut its rate by only 22 percent over the same period, and rates have barely budged since the early 1990s.

Ironically, this means less revenue for the federal government. In the 1950s, corporate taxes made up almost a third of federal revenue. Today they only contribute about a tenth.

The U.S. Treasury is not the only loser. American workers fare even worse. Since capital can move overseas to escape high taxes, but workers cannot, companies are forced to cut wages instead of shareholder returns in order to pay American corporate taxes. Economist R. Alison Felix of the Kansas City Federal Reserve calculated that for every additional dollar in revenue raised by the corporate tax, wages decline by four dollars.

The distortionary effect of corporate taxes is well-documented. One paper from the OECD found that corporate taxes are the most harmful for growth of any common type of tax—more harmful than individual income taxes, consumption taxes, and property taxes.

To bring corporate income back to the United States, policymakers should consider lowering the corporate tax rate or abolishing the tax altogether. Given the declining importance of the corporate tax to federal coffers, a rate cut to 25 percent would cause a revenue loss of less than 2 percent, while adding $404 billion to GDP. At the very least, the tax should only apply to corporate income earned in the United States, not worldwide, so businesses like Pfizer are less inclined to invert in order to avoid double taxation.

Politicians who blame Pfizer for relocating to Dublin are barking up the wrong tree. America’s punitive corporate tax system is the real villain behind these inversions.

Preston Cooper is a policy analyst at the Manhattan Institute. @PrestonCooper93