Fun and games with transfer pricing
ProGrowthLiberal in his comments on my last post and in his own post at EconoSpeak highlights the fact that drug-maker AbbVie already makes most of its profits outside the United States, about 87% in fact over 2011-2013 by his calculation. For PGL, then, AbbVie is not the best example of an inversion because the horse is already out of the barn in terms of escaped profits.
I see things a little differently on this, but the case is also highly illustrative of a principle we have discussed before, transfer pricing. Let’s take a look at AbbVie’s Form 10-K Annual Report, downloadable here, to see what I mean.
Pre-tax profits ($millions) 2013 2012 2011 3-year total
U.S. -581 625 626 670
Foreign 5913 5100 3042 14,055
Total 5332 5725 3668 14,725
Source: AbbVie Annual Report, p. 92
I actually calculate the foreign percentage for these three years as 95%, given that AbbVie claims to have lost money in the United States in 2013. In any event, this is a very strange division of the company’s profits given where its sales were made.
Net sales ($billions) 2013 2012 2011
U.S. 10.2 10.4 9.7
Foreign 8.6 7.9 7.7
Total 18.8 18.4 17.4
Source: AbbVie Annual Report, p. 40. Totals may not sum due to rounding.
As you can see, in each of the three years, over half of the company’s sales were made in United States, but the company reports that only 5% of its profits are in this country. This is pretty funny math, if you like dark humor. Especially since Humira, AbbVie’s biggest-selling drug by far, was developed in the United States. So with the patents in the U.S., and most of the sales in the U.S., the profits have to be in the U.S., right?
In reality, of course they are, but not in the Alice’s Wonderland world of transfer pricing. In this byzantine world, the patent for Humira is almost certainly owned by a subsidiary in Ireland, where royalty payments are tax-free. How else could the company show a loss in the United States in 2013 when 54% of its sales are here? Despite this, the company reports paying about 39% of its worldwide income taxes ($226 million of $580 million worldwide, see p. 92), although we have seen that what companies report in taxes on their 10-K annual report is largely fiction
So what can we do? The answers remain simple, though as politically difficult as ever. First, require companies to publish what they pay, country-by-country. No more hiding behind consolidated accounts. Second, enact unitary taxation, using apportionment formulas to make transfer pricing irrelevant. Third, end the deferral of U.S. corporate income tax on foreign profits. Finally, despite what “everyone,” including the President, says, don’t reduce the corporate income tax rate. We’ve gone long enough with tax policies that exacerbate inequality; there’s no reason to continue down that road when we have the world’s largest economy.
Oh, and my tiny disagreement with ProGrowthLiberal: It seems to me that if a company is already draining giant chunks of its profits abroad, then allowing an inversion ratifies losing a bigger amount of tax money than it would for a company like Walgreen’s that has not moved its profits offshore yet. But I imagine the IRS could still go after AbbVie post-inversion if it wanted to question its pre-inversion transfer prices, so this is a minor point indeed.
Cross-posted from Middle Class Political Economist.
Yes, we could do all 3 things you suggest or…we could simple do an automatic transaction tax right at the bank and grab what they owe as they move their money in and out of our banks.
No more worry about transfers, offshore and inversions. Or they can try some other country’s currency to buy and sell in the US.
And just for good measure, if their patent came from any part of any government funded research, they can pay an additional couple 10ths as a recoup for what the people bought them. And a thank you note every year to the US citizen for good measure.
I am not a tax guy, but I seem to recall that when dealing with a C corp, that dividends are not deductible. That is the reason that the personal income tax on dividend income has been at a special rate because of the “double taxation” problem.( Personally, I think the corporate fiction gets a whole lot more from government than the individual shareholder and reject the idea that there is double taxation.) Although it is not the inversion issue, I understand that a lot of corporate profits are parked overseas because of the “confiscatory” corporate taxes that companies would have to pay if they brought the money back. I have to believe that this does not make shareholders too terribly happy because even if the money is invested overseas, at some point the shareholders own that profit and if they live in the U.S. would like to stay here rather than moving to Ireland to get it. If the tax law was changed to permit corporations to bring money from overseas to this country and not subject it to tax provided it was distributed to shareholders as dividends, the shareholders–many of whom are extremely wealthy, but some of whom are widows, orphans and just plain middle class folks with mutual funds or small portfolios–would pay some tax and might well spend or further invest the income helping the economy. Further it would seem that as apathetic as most shareholders are when it comes to corporate governance, that some smart guys and gals could mount proxy fights to “set our money free”
With respect to inversion, I see the same thing as occurs constantly in the states–it is a race to the bottom between countries, just as it is a race to the bottom among states all in pursuit of jobs. It is essentially a combination of the inmates running the asylum and beggar thy neighbor economic policy. We are bound by the Constitution and principles of federalism when dealing with the states, but we only have free trade agreements when dealing with international trade. I understand the concepts of natural advantage where free trade allows the U.S. to grow food better than Ireland while Ireland can make fine lace better than the U.S., but I see no place for a natural advantage in sucking up to corporations. How about conditioning free trade agreements on certain minimum standards of corporate taxation? While we are at it, we could put in some intellectual property protections. While we might ignite some trade wars, everyone including the corporations would figure out pretty quickly that trade wars are not good for business. Neither of my proposals seems infeasible, nor do they constitute “socialism” or communism” but they will never happen because the corporations own both major political parties.
“Corporations own both parties.” That is the real nub of the problem. The U.S. market is so essential to the multinationals that we can get away with any equitable tax policy from a business perspective.
I would make it simple. I would repel the corporate income tax and tax corporate dividends and capital gains as individual income, ending the special status of those two categories of income.
Your tax receipts might go down, you would be sacrificing the taxes paid by foreign customers and shareholders of US corporations through the existing corporate income tax. We might have to raise income taxes on US based tax payers to compensate, but I don’t think that it would be much. (You could always require withholding from dividend payments and require foreign based stockholders to file US taxes to claim it. )
I have seen various estimates of the effective corporate income tax rates of what everyone thinks of when they hear the word corporation, the large corporations with shares listed on a stock exchange. It ranges between 9% and 20%. You might even increase the taxes paid on corporate profits by taxing them at the individual income tax rates, even with a reduced tax take from foreign customers and shareholders.
More than 95% of the corporations in the US are professionals; architects, doctors, lawyers, engineers, etc. registering as corporations to take advantages of more liberal deductions allowed to a corporation and other special S corporations, all set up to take advantage of tax breaks. I am an officer of three such corporations, and I am retired!
Doing it this way would eliminate 75% of the corporate lobbying that is undermining our democracy and corrupting our elected officials. It would eliminate the dual bookkeeping of corporate profits and the off shoring of those profits. It would eliminate the special treatment of capital gains of course. I haven’t seen a compelling argument for this tax treatment yet. After all in more normal economic times increases the prices of assets is mostly due to inflation, not clever, worthwhile investment, right?
It would help to get rid of this idea that a corporation is a person for political purposes.
Sorry, I didn’t complete my thought about the S corporations. They are already taxed at individual income tax rates bu. with the more liberal deductions that are allowed to corporations. I’d eliminate them also. Yes, I would have to pay more taxes.
Daniel: There is merit in what you say. A financial transactions tax could raise a ton of revenue, depending on the rate. I actually like Tobin’s original idea of taxing foreign exchange transactions (at least $3 trillion a day globally) to throw some sand in the wheels of capital mobility. Moreover, there is growing momentum for a transactions tax in the EU and (maybe to a lesser extent as long as the Conservatives are in power) Canada.
Terry: The European Union has good control over one race to the bottom, corporate subsidies. The European Commission is now investigating what special deals Ireland gave Apple, tentatively viewing them as illegal “state aid” (subsidies).
Merkin: If you wait until corporations distribute dividends or capital gains, you open up a new can of worms. They may never get taxed if they are put in an estate (especially with the basis step-up on death). You need a corporate income tax as a backstop to the personal income tax.
When I look at the rush of drug companies into “inversions” I wonder what it is that the CEOs see that leads them to try this complex tax avoidance scheme.
I suspect that they are looking at their pipeline of new drugs coming on the market and old established drugs losing their patent protection and concluding that their era of superior profits growth is coming to an end.
For decades drug companies have been among the most profitable US industries and best performing stock market industries, I have to conclude that the CEOs can clearly see that this era is coming to an end.
Does anyone have a better explanation as to why inversions are suddenly so popular among drug companies, but not other industries?
As far as I am concerned any drug companies doing inversions immediately becomes a sell candidate because the CEOs revealed preference is that their stocks are too expensive.
It’s not limited to drug companies. In Illinois we have Aon (insurance) gone to England and Walgreen’s considering Switzerland. I continue to believe that a tax on profits tied to percentage of sales in the U.S.,regardless of the “citizenship” of the corporation would go a long way to reasonable financing of government operations with fairness to all corporations doing business in the U.S..