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The Wrong Solution to the Pfizer Problem

by | May 16th, 2014 | 02:11 pm
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Senator Ron Wyden (D-OR), chairman of the Senate Finance Committee, has rightly identified a major weakness eroding America’s long-term prosperity: a tax code that pushes multinational corporations (MNCs) to establish their headquarters in countries other than the United States. His op-ed in the Wall Street Journal [subscription required] on May 8 was inspired by Pfizer’s effort to acquire AstraZeneca and thereby move its headquarters from New York to London, in part to escape high US corporate taxes.

Were Pfizer to carry out its intention to move abroad, much of the corporate brainpower is sure to follow. This cannot be good for US leadership in research, finance, or marketing. To discourage such moves, Senator Wyden proposes two remedies. First, he would lower the federal corporate tax from 35 percent to 24 percent, bringing the US rate roughly in line with its advanced country competitors in the OECD (Organization for Economic Cooperation and Development). Second, he would tighten the barn door by raising the minimum threshold of foreign ownership before a US-based MNC can reincorporate abroad, and successfully depart from the US tax net with respect to its non-US operations, from 20 percent to 50 percent.

These prescriptions might do some good, but they fail to address a fundamental problem. MNCs must incur huge research and development (R&D) costs and other investment outlays to stay competitive. To recover these costs and earn a decent profit, they must produce and sell in world markets. As part of their growth strategies, many countries—not just Ireland and Switzerland, but also India and China—tailor their tax laws to attract MNC factories, service centers, and research facilities.

Apart from the United States, other MNC headquarter countries either do not tax income earned by MNCs from their foreign affiliates, or they tax that income at very low rates. But the United States insists on taxing foreign income at the full federal rate of 35 percent (allowing a credit for foreign taxes paid) when the income is repatriated. The Obama Administration has even insisted that the foreign income should be taxed at the federal rate even when it is not repatriated. Current US tax rules, and even more the administration proposals, severely damage the competitive position of US-based MNCs by comparison with their challengers based in Britain, Germany, Japan, Korea, and almost all other countries.

To ensure a level playing field for today’s US-based MNCs, the United States must adopt a territorial corporate tax system (accompanied by anti-abuse provisions), just as nearly all other countries have done. Under a territorial system the United States would tax income earned by MNCs at home but not income earned abroad.

More important than a level playing field for today’s MNCs, the United States must make itself competitive for the MNCs of tomorrow. Ten years from now, many new MNCs will enter the Fortune 1000 list. Senator Wyden can ensure that a large proportion of the newcomers are headquartered in the United States if he adds territorial taxation to his proposals. However, if he simply tightens the barn door and just lowers the US corporate rate to today’s average for OECD countries, Senator Wyden will pave the way for future MNCs to locate their headquarters outside the United States.