U.S. Corporations Don’t Need Tax Breaks on Foreign Profits

Yves here. Notice that the justification for tax breaks so that corporations can show more profits is “competitiveness” that we’ve debunked repeatedly. As we wrote last year:

One of the things that has worked in the favor of corporate and individual tax gamesmanship is that tax, and particularly cross border tax, is so complex as to induce MEGO (My Eyes Glaze Over) among just about anyone other than serious professionals. I’ve noticed, for instance, that attorneys in specialities other than tax seem if anything to have more of an antipathy to tax issues than mere mortals.

And that suits everyone on the inside. Complexity assures limited entry into the discipline which in turn means high pay levels for those with expertise. It also helps lobbyists push for regulations that further lard up the tax code, since politicians can tell their constituents they’ve done something for them (“Tax incentives for the locally pottery kiln”). Those provisions also serve corporations and the wealthy generally, since they further the use of tax reduction as an illusory economic stimulus. In fact, the main effect is a race to the bottom on corporate taxes, which results in a shifting of the tax burden to regressive consumption taxes and not-very-progressive personal income taxes. In other words, tax avoidance has long been a means for redistributing income to the capitalist classes.

One issue that Lazonick does not mention is that these companies are complaining about how tax treatment intersects with public reporting. The funds that are “offshore” are “offshore” for tax purposes only. They are typically kept in the US in New York banks. For instance, Apple manages its “offshore” monies as an internal hedge fund out of Nevada.

By William Lazonick, professor of economics at the University of Massachusetts Lowell, where he directs the Center for Industrial Competitiveness. Originally published at the Institute for New Economic Thinking website

Many Americans have expressed outrage over Pfizer’s plan, through its merger with Allergan, to move its tax home from the United States to Ireland. Now, in a New York Times op-ed, Carl Icahn, the billionaire corporate raider turned hedge fund activist, has joined the chorus. He labels the Pfizer-Allergan deal a “travesty,” blaming the U.S.’s “uncompetitive international tax system.”

The purpose of Icahn’s article is to promote a proposal by Sen. Chuck Schumer, D-NY, and Sen. Rob Portman, R-OH, to lower the U.S. tax rate on profits that U.S. companies repatriate from abroad, from 35% to 10% or lower. U.S. corporations are holding $2.6 trillion beyond our borders, waiting for a tax break before bringing the money home. The proposal, according to Icahn, would generate an estimated $200 billion in federal tax revenues on those holdings. That, he says, “would allow companies to reinvest the nontaxed portion in the United States, creating thousands of jobs.” That does not sound like too much job-creation bang for $2.6 trillion in repatriated bucks, but don’t believe for a moment that job creation is what Icahn has in mind. All the evidence says that the proposed Schumer-Portman tax break on repatriated profits would be used to further enrich people like Icahn, who make their fortunes by extracting value from companies, not by creating value in them.

We’ve seen this movie before. In 2003, the Bush Administration pushed through the Homeland Investment Act, which provided a one-year-only tax break on repatriated profits, with the stipulation that these profits had to be used in the U.S. for investments that create jobs. U.S. corporations responded by bringing back $299 billion in profits in 2005, compared with an average of $62 billion from 2000 to 2004 and a subsequent decline to $102 billion in 2006.

The Homeland Investment Act expressly prohibited the use of these repatriated profits to pay dividends or do stock buybacks. Yet an academic study found that “rather than being associated with increased expenditures on domestic investment or employment, repatriations were associated with significantly higher levels of payouts to shareholders, mainly taking the form of share repurchases.” The researchers estimated that for every $1 increase in the amount repatriated in 2005, the companies increased distributions to shareholders by $0.60 to $0.92, mainly as repurchases. The companies sidestepped the intent of the Act by claiming that domestic funds, not the repatriated profits, had been used for the increased payouts to shareholders.

As I argued in my Harvard Business Review article “Profits Without Prosperity,” U.S. corporate executives have become addicted to buybacks. From 2005 to 2014, 458 S&P 500 companies expended $3.7 trillion on stock buybacks, representing 52.5% of net income, plus another 35.7% of net income on dividends. These companies held much of the remaining 11.8% of profits abroad, sheltered from U.S. taxes. FactSet Research calculates that in the 12 months ending with September 2015, S&P 500 companies spent 64.6% of net income on buybacks, with 130 companies spending more than 100% — both record numbers since the 2008–2009 financial crisis.

As for Icahn…he may be trying to sell the Schumer-Portman plan by positing that some $2.6 trillion in repatriated profits will create “thousands of jobs,” but I believe what really excites him is the prospect that companies in which he holds shares will have billions of dollars more of “free” cash flow for buybacks and dividends. Of greatest concern for Icahn is Apple, a company in which he holds shares valued at about $5.8 billion. The hedge fund activist wants Apple to double its stock price, with massive buybacks as the lever. Indeed, with Icahn’s urging, over the past three fiscal years Apple did $103 billion in buybacks along with distributing $33.3 billion in dividends. At the end of fiscal 2015 (September 26), Apple had $187 billion in liquid assets abroad, up $50 billion from a year earlier. Yet with all its foreign cash, Apple borrowed over $62 billion in 2013–2015 to do buybacks rather than repatriate its profits and pay U.S. taxes.

Which brings us back to Pfizer, the pharmaceutical drug company that has provoked the new round of patriotic denunciations of corporate tax flight. Pfizer’s CEO, Ian C. Read, has justified the corporate change of address from New York City to Dublin by complaining that U.S. tax policy puts his company at “tremendous disadvantage” in international competition. “We’re fighting,” Read told The Wall Street Journal, “with one hand tied behind our back.”

I have shown, however, that if Pfizer is handicapped, it is because since 1985 the company has distributed 113% of net income to shareholders. Since 2011, Read’s first full year as CEO, Pfizer has expended $44.2 billion on buybacks and $31.2 billion on dividends — together representing 121% of net income — while provisioning $16.2 billion for income taxes, much of which are charges for possible future repatriations of profits and hence taxes that may never actually be paid. As I have detailed elsewhere, Pfizer’s business model is to merge with companies with proven blockbuster drugs, and then, with drug prices in the U.S. that are at least twice as high as anywhere else, generate revenues until the patents run out — all the while devoting all the resultant profits and more to “enhancing shareholder value.”

Given their financial behavior, major U.S corporations do not need tax breaks. Before Congress capitulates to Icahnic moans that the U.S. international tax system is depriving the super-rich of their next billion dollars, it should focus its attention on how U.S. corporations have been abusing the profits that are generated at home. Vice President Joe Biden, Sen. Tammy Baldwin, Sen. Elizabeth Warren, Sen. Bernie Sanders, and Democratic presidential hopeful Hillary Clinton, among others, have recognized that stock buybacks manipulate the market and leave most Americans worse off. U.S. citizens need policy makers committed to bringing under control the greed that runs rampant in the C-suite and on Wall Street.

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  1. Joseph B. Borgo

    The real underlying problem here is the US policy position that taxes US citizens and resident foreign nationals on their worldwide income. We are one of the few companies in the world to do so. Most other advanced economies tax your income in the jurisdiction in which it is earned. The international community needs to agree on a common policy that makes sure that all taxes due are fully paid in the jurisdiction where the income was earned. After that, companies and individuals should be free to move their financial assets around at will to take advantage of the best investment opportunities.

  2. Erick

    I worked as a consultant at Pfizer for 10 years, on the same floor of their NY HQ as the global tax group. I can tell you that even back then, the pecking order was Tax –> Sales –> Marketing –> R&D. It was a finance company that also happened to make drugs.

    1. Robert Frances

      Another drug company that developed the birth control pill could be a case study for Corporate Tax Planning 101. The company’s US sales and marketing base was located in Silicon Valley, CA but the pill itself was developed in a country with a zero corporate tax. Back in the early 80’s the big SV technology companies were paying a 35-40% corporate tax rate, but they noticed Syntex(?) was paying only 2-3% since the primary profit was related to the drug technology and wasn’t taxed in the US. (The US company likely paid very large licensing fees to the foreign parent corp.) All large SV companies quickly learned from drug companies like Syntex that the key to lower corporate taxes was to transfer the company’s very valuable core technology offshore as soon as possible (via cost-sharing agreements) and “earn” those profits overseas, preferably some place with a zero tax rate. One legacy of British imperialism is that some of these low-no tax countries still remain.

      Splitting off the manufacturing process is another great tax-saving tool since the profit associated with “managing” the contract manufacturing can be captured at a low-no overseas tax rate too, avoiding US tax until the money is paid as a dividend to the US company.

  3. Robert Frances

    It bears repeating: Corporations don’t pay tax, only humans pay tax.

    Large businesses organized as corporations, partnerships and trusts may be very effective tax *collectors*, but the current profits-based tax system is among the worst systems possible because it’s relatively easy to shift profits to low-tax locations and shift costs to high-tax locations. For anyone bemoaning the decline in tax revenue collected from large business enterprises such as corporations, I’d ask you if we were discussing your own personal affairs whether you would consider moving to the city/town next door if you could reduce your tax payments by 1/2 or more. If so, you’ll recognize why every large US corporation is having the same conversation in the C-suites.

    In a globalized world where significant future economic activity will be happening in places like SE Asia, Africa and South America compared to countries like Japan and the mature western economies, it makes perfect sense for corporate executives to consider moving a corporation’s “home” away from countries like the US that tax world-wide income and restructure or merge with a company located in another country that uses a territorial based tax system where foreign profits are tax-free in the “home” country.

    If anyone is interested in collecting more tax from large businesses enterprises like corporations, advocate for taxing gross receipts instead of profits. A relatively simple system could exempt small businesses (under $1M of sales) and impose a graduated tax of 1-5% on the gross receipts of larger business enterprises. A tax credit system can be used to mitigate tax-on-tax issues. The tax revenue raised would be so significant that the government could start reducing regressive payroll and sales taxes, which would put more money into working family’s pockets, creating jobs and economic activity in the process.

    1. KLD

      What is especially galling is they still get to use all of the infrastructure we citizens get stuck paying for.

    2. David Mills

      On a similar vein, if capital structure is: A) discretionary, and B) irrelevant, then eliminate the tax deductibility of interest payments. Furthermore, make corporations liable to pay tax when “profits” are declared. Done.

    3. run75441


      So companies pay payroll taxes on income at the same percentage as people do? I do not “believe” it is the same tax we are talking about here.

      What you are suggesting is companies move away from the largest consumer market in the world to avoid Overhead costs which include all of the infrastructural costs for the physical attributes of the US, social costs such as Unemployment, Workmans Comp SS, etc.

      I believe a better solution would be to tax those companies,who have used Inversion to avoid these costs, on the sales of their product in the US.

      1. Robert Frances

        One of many positive benefits to a tax based on US gross receipts is the system collects more tax from foreign companies that sell in the lucrative US market. It also rewards companies who create jobs and business investment in the US since their foreign sales wouldn’t be subject to the tax. A Mercedes sold in the US would be fully taxed (unlike now where much of the overall car profit is *not* subject to US corporate tax). A Chevy manufactured in the US and sold overseas would not be subject to a US gross receipts tax.

        Re: your payroll tax comment, governments use dozens of taxes to collect revenue. Spreading the tax burden around seems to confuse and divide us. In the end, however, it’s a closed economic system of humans interacting with each other. Production, consumption, government services and taxes all happen within the same ecosystem. Governments typically tax: labor (payroll taxes paid by E’ee and E’or); retail sales (paid by consumers); personal income taxes; property taxes (paid by tenants or homeowners); business and corporation taxes (paid by customers and/or shareholders and/or employees), along with dozens of other taxes, fees, duties, etc.

        From policy and economic justice perspectives it’s much more efficient and fair to let businesses collect the bulk of our taxes, with the largest businesses paying the highest tax rates, and the smallest businesses paying little to no tax. A graduated GRT is easy to calculate and relatively easy to audit. Graduated tax rates can be easily scaled to collect an equivalent amount of tax as currently collected via payroll taxes (federal), sales taxes (states/cities), and business taxes (including the corporation profits tax).

        Some people prefer a lower tax burden. Others wish more taxes were collected. But regardless of how much tax revenue the government raises from the population, the manner in which the taxes are raised may be as important as how the tax money is spent.

        1. run75441


          I do not sense we are far away on this as I am talking something similar in a simple language less embellishment. Forget confusion, lower taxes, etc.I already understand the ecosystem. It makes sense to tax companies that use the infrastructure and Labor and who also seek to avoid the cost of infrastructure and Labor. Now who are you going to convince?

          Lets also understand something, corporations are people as decided by SCOTUS and capable of making political donations, decide birth control, etc. It is only a matter of time for this to be expanded. This has opened the door to stating corporations as people who should pay pay taxes if they are selling in the US.

  4. DJG

    Many problems here with your traditional argument that corporations just shouldn’t have to pay taxes (as if globalization were a factor):

    So you and millions of others are planning to move from New York City to Oklahoma to avoid taxes? After all, you start by making the mistake of comparing a household to a corporation. In this case, both households and corporations consider amenities. (Not having to send a child to the University of Oklahoma when SUNY is that much better.) So to go only with your household example,, a corporation that wants the amenities of U.S. corporate status should feel free to move to Vietnam if it feels like it?

    And globalization? I won’t go much further than to point out that you use globalization is an excuse.

    In the end, you want to tax gross receipts at a low rate. Why am I not surprised at this non-solution?

    1. Robert Frances

      I think you read what you wanted and not what I wrote. I said artificial entities don’t pay taxes since only people pay taxes, but that large businesses could be good tax *collectors* for society assuming the government used an effective tax system. A profits-based tax system is a terrible system since tax manipulation is so easy, whereas a gross receipts (GRT) system makes more sense and is nearly impossible to manipulate. (The location of sales is far easier to determine than the location of profits.) The overall tax collected by a GRT could be the same as currently collected using the tax on profits system, although I’d argue for eliminating all regressive payroll and sales taxes and collect the same (or more) tax by replacing those taxes and imposing the tax directly on businesses using a GRT.

      Believe or not, but a graduated 1-5% tax on business gross sales in the US would likely raise far more revenue than the current 36% tax on net profits. (A ~40% tax rate if state corporate taxes are included.) The tax administration costs would, however, decrease dramatically, which would free up government spending for other needed services.

  5. michael savoca

    As Robert Francis above states, ” It bears repeating: Corporations don’t pay tax, only humans pay tax.”

    hmmm, so if each individual worker were to incorporate, no one would have to pay taxes, and we could have national defense, paved roads, bridges, schools, public safety and all the rest for free !

    all sarcasm aside a fair tax system would be one where all transactions (all), without exception are taxed at one low fixed rate and people living below poverty level get a modest , graduated rebate.

    yes, all transactions to be taxed, including a tax on all financial transactions and even donations to so called non-profit organizations….no exceptions….one low fixed rate for all, no more games with bought legislators paying off their sugar-dadies with special exemptions, deductions, depreciation allowances and all the rest of the manipulations of tax law.

    1. Melody

      As an economic-illiterate, I’ve considered this, too, relying on high school geometry theorem that if A = B, then B = A. This said, if corporations are people, people ARE corporations. From this (sarcastic) viewpoint, everything needed to keep the organism functioning (corporate or human) becomes a deductible ‘business’ expense. Food, clothing, shelter, healthcare, R&R, transportation, communications, childcare, janitorial/cleaning services, etc–all become deductible necessities, to be subtracted from gross income before determining taxable income. At this point, would our society cease to function–or at the very least, would SCOTUS rethink their “corporations are people’ edict?

  6. Theo

    again, i am routinely doing a test to see what verizon keeps marking as spam from this website
    it marked this article as spam once again

  7. Theo

    again, i am routinely doing a test to see what verizon keeps marking as spam from this website
    it marked this article as spam once again

    i said this under an earlier article, not this one
    you have rejected this comment in error

  8. Larry

    I think you could file this under a new series/heading: Elites Pull up Their Oars. The global elite seem quite content to simply extract as much as they possibly can from the current system before it simply exhausts itself. Stock buybacks, dividends, “privatization” of the public sector. At all times, maximize your personal return at the expense of the many, and don’t worry a damn about the future.

    1. run75441


      Time to turn the tables on who gets to use the US for personal benefit and gain at “our” expense.

  9. avgjohn

    Eliminate all tax regulations related to public corporations, calculate income tax based on publicly issued income statements, with a simple tax credit for payroll (excluding officers), and a credit for foreign taxes paid.

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