Photo by and courtesy of The Montgomery County Planning Commission on Flickr
The Soviets and their East German clients built the Cold War barrier in 1961 to prevent citizens from fleeing to the West to try to create a better future with their labor and their skills, which the communists treated as state property. Ronald Reagan went to Berlin in 1987, stood at the Brandenburg Gate, and issued his challenge. Less than three years later, the wall fell.
Today, American corporations are defecting – we don’t use the word, but that’s exactly what it is – by the dozen. Just as East Germans wanted to put their labor to better use in other lands, U.S. corporations want to use their collective $1 trillion or more of accumulated offshore profits for something more productive than sitting in bank accounts.
But corporations can’t invest that capital domestically, and they can’t return it to their shareholders in the form of dividends, thanks to an American tax system that is unique in the developed world for its perversity. America, and America alone, declares that companies incorporated here must pay U.S. tax on income earned elsewhere, even if it is paid in dividends to shareholders who live elsewhere too. It isn’t a tax on American profits; it’s a tax on the increasingly undesirable circumstance of being organized and managed in the U.S.A.
The latest and largest corporation to make a run for freedom is Pfizer. The pharmaceutical giant wants to become a British company by acquiring its pharmaceutical rival AstraZeneca. The acquisition is not yet certain, and AstraZeneca’s drug portfolio would likely have made it an attractive target regardless of its geography. But the U.K. address caught the attention of Pfizer’s leadership. Pfizer says it would still be traded on the New York Stock Exchange and keep its headquarters in New York, and so it would – for as long as it is run by the current generation of managers who happen to live there, anyway.
There are some people in Washington who recognize how self-defeating and foolish our current corporate tax regime has become. Sen. Charles Grassley, R-Iowa, said, “Until we can reform out tax code so we have a more globally competitive system, businesses will seek ways to limit their taxes in the United States in favor of foreign tax systems,” The New York Times reported.
Yet there are others, including the current president, who sees the problem only as a form of leverage to try to extract still more taxes. If he can’t get that revenue from corporations, the president wants to get it from his favorite target, high-income individuals. In short, what he really wants is to tax prosperous Americans to make up for the loss of tax revenue on corporate profits that are earned offshore.
Raising individual tax rates only makes the problem worse. If Pfizer wants to pay $1.25 worth of dividends to a high-income Californian, the company must earn $3 of profit in order to do so. First, Washington would take 35 percent via corporate taxes. From the $1.95 that remained, subtract federal income tax on the individual shareholder (another 23 percent, after several Obama tax increases). On top of that, there is a 13 percent top rate at the state level in California. So when Pfizer pays the $1.95 dividend to that Californian, she pays 70 cents in personal taxes, leaving her with the intended $1.25 to actually spend. Government at the state and federal levels takes the other $1.75 – more than half the total profit.
Obama’s 2015 budget proposed to ban American corporations from defecting, by prohibiting them from reorganizing abroad after acquiring a foreign company. An American president is essentially attempting to tell American companies that they have no choice but to remain American forever. If this brings to mind old images of Nikita Khrushchev and a wall rising in Berlin, it is understandable.
Whether or not the language banning defection makes it through in the form the president proposed, it is enough to make corporations like Pfizer move quickly in order to secure a merger before Washington can block the way. Our tax rate has already driven high-profile businesses elsewhere; if it seems that it is about to become harder to escape confiscatory corporate taxation, companies besides Pfizer may decide it is worth the risk to rush things a little.
Perhaps the president is unaware that corporate acquisitions are a two-way street. If a company like Pfizer can’t acquire other firms, it becomes an acquisition target itself. What is the president going to do? Will he tell Americans that they can’t sell their shares to foreigners? Or will he tell foreigners that they are free to buy American companies but not free to manage those companies elsewhere, or to liquidate them? How does he propose to get foreign nationals to turn over foreign-held profits from foreign operations to the U.S. Treasury?
The Wall made defecting to the West riskier, and it slowed the tide of escapes, but it never stopped them completely. Eventually, like all such barriers in history, it crumbled. Obama or another president might manage to build a wall. But keeping it intact over the long term is another matter. Just ask Mikhail Gorbachev.
Larry M. Elkin, CPA, CFP®, has provided personal financial and tax counseling to a sophisticated client base since 1986. After six years with Arthur Andersen, where he was a senior manager for personal financial planning and family wealth planning, he founded his own firm in Hastings on Hudson, N.Y., in 1992. That firm grew steadily and became the Palisades Hudson organization, which moved to Scarsdale, N.Y., in 2002. The firm expanded to Fort Lauderdale, Fla., in 2005 and to Atlanta in 2008.