Corporate Exits Accelerating, Taking Jobs with Them

April 25, 2014

It’s been a busy week for corporate mergers and acquisitions, many of which appear to be driven by the extremely high U.S. corporate tax rate and the desire to get out from under it.

Pfizer has been in talks with U.K.-based AstraZeneca about a merger that would result in the new company located in the U.K., where the corporate tax rate is going to 20 percent next year. That’s about half the corporate tax rate in the U.S., counting the federal rate of 35 percent plus state corporate taxes.

Valeant Pharmaceuticals of Canada is planning to buy Allergan Inc. of California. The new company will be based in Canada where the corporate tax rate is 26 percent, thus avoiding the U.S. federal corporate tax rate of 35 percent and the California corporate tax rate of 9 percent.

Bloomberg also reports on GE’s plans to buy Alstom SA of France with $57 billion of cash that GE has stashed overseas, partly because GE would otherwise be hit with the U.S. repatriation tax if the company were to bring those profits home.

U.S. companies are merging with and acquiring foreign companies at an accelerating rate, often with the goal of moving the headquarters abroad where corporate tax rates are much lower. Another factor is that most developed countries outside the U.S. have a much better treatment of multinational foreign earnings. These countries use a territorial tax system that largely exempts foreign earnings of multinationals from domestic taxation, leaving them to pay corporate tax only in the countries in which the profits are earned. The U.S., in contrast, tacks on an additional repatriation tax if foreign earnings are brought back to the U.S. This is known as a worldwide tax system. See the chart below, showing that only 5 other developed countries tax multinationals on a worldwide basis, and none of them at such a high corporate tax rate.

So when headquarters leave the U.S., how many jobs are lost? One might think that only a few corporate executives leave, while most of the companies’ workers are left in the U.S. Apparently, this is not the case, according to Bloomberg:

Alexion Pharmaceuticals Inc. used a similar playbook to lower its taxes for this year. The producer of drugs for a rare blood disorder said in January it was changing its tax status by centralizing its supply chain to Ireland, where the company bought a factory.

Since Alexion only makes one product, shifting manufacturing and intellectual property to Ireland enables the company to lower its tax liabilities, said Kimberly Lee, an analyst at Janney Montgomery Scott LLC.

As a result, Alexion, whose executives manage the company from Cheshire, Connecticut, expects its overall tax rate to fall to 10 percent or 11 percent for 2014, the company said.

Actavis agreed in February to pay $21 billion to acquire Forest Laboratories Inc. (FRX), setting Forest up for a tax domicile move to Ireland. Before that deal was done, Forest bought Aptalis Inc. so it, too, could move some of its taxable income offshore.

Valeant also bought Bausch & Lomb Inc. for $8.7 billion last year, enabling the company to pull the Rochester, New York-based company into its lower tax base.

These deals often happen in pharmaceuticals or other industries where a lot of a company’s value is in intellectual property, Caplan said. It’s easier to move intellectual property than it is to move factories.

That said, even some industrial companies have changed their tax domicile by acquiring a rival. Industrial equipment maker Eaton Corporation Plc acquired Cooper Industries Plc in 2012 and adopted its Irish tax domicile. That year, Eaton lowered its effective tax rate to 2.5 percent from 12.9 percent a year earlier, according to its annual report.

Eaton paid $31 million in income tax on $1.3 billion in pretax income in 2012 compared with $201 million in income tax on $1.6 billion in pretax income in 2011, data compiled by Bloomberg show.

That is, these companies leaving is not just a tax revenue problem for the U.S. government, it is a jobs problem for the U.S. economy. The solution is to cut the corporate tax rate and drastically, and switch to a territorial tax system. The OECD average corporate tax rate is 25 percent, while the U.S. rate is 39 percent. This is not even close.

President Obama has proposed lowering the U.S. rate 7 points, to 28 percent at the federal level. With state taxes that would still leave the U.S. with a combined corporate tax rate of about 32 percent, which would be higher than every developed country except Japan, France, and Belgium. This is not competitive.

Worse, the President proposes to raise corporate taxes in other ways, so that the effective corporate tax rate is roughly unchanged. This ignores the fact that the U.S. effective corporate tax rate is also extremely uncompetitive, in fact it is nearly the highest in the developed world.

On top of all this, the President refuses to allow a more competitive international tax regime, i.e. a territorial tax system like that found in most of the developed world. Instead, he proposes raising taxes on U.S. multinational companies and their operations abroad.

It’s time to stop playing games with the corporate tax. It is too high, too punitive and utterly uncompetitive. It’s hurting everyone, particularly the millions of Americans who work at corporations.

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