Letters to Switzerland: Tax Breaks for Big Pharma But No Job Creation

A couple of years ago, we paid tribute to Bob McIntyre and to David Cay Johnston for recognizing how U.S. based multinationals can abuse the transfer pricing regulations to shift income abroad to low-tax jurisdictions. Johnston’s Letter to Switzerland chapter focused on how Big Pharma plays this game.

An international tax guru might fire back that Big Pharma eventually pays taxes when the profits are repatriated. OK, these companies get to defer taxation and the present value of $1 million in tax paid in 10 years is a lot less than the $1 million without the deferral benefit. But this gets better as reported today by The New York Times:

Two years ago, when companies received a big tax break to bring home their offshore profits, the president and Congress justified it as a one-time tax amnesty that would create American jobs. Drug makers were the biggest beneficiaries of the amnesty program, repatriating about $100 billion in foreign profits and paying only minimal taxes. But the companies did not create many jobs in return. Instead, since 2005 the American drug industry has laid off tens of thousands of workers in this country. And now drug companies are once again using complex strategies, many of them demonstrably legal, to shelter billions of dollars in profits in international tax havens, according to their financial statements and independent tax experts. In one popular accounting move, companies declare their foreign markets as far more profitable than their American businesses – even though drug prices are typically higher in the United States than anywhere else in the world. Drug makers are not the only American multinationals using tax loopholes to declare large portions of their income beyond the reach of the Internal Revenue Service. The Brookings Institution estimates that multinational companies are using overseas tax shelters to lower their payments to the Treasury by about $50 billion a year. But the drug industry accounts for one of the biggest portions of that shortfall, according to the I.R.S. and independent tax experts. And the nature of their business gives drug makers techniques, like sheltering valuable pharmaceutical patents in tax-friendly havens like Ireland, that many other industries cannot use. Moreover, the sheer heft of the American drug industry, which had about $60 billion in pretax profits last year, can give disproportionate weight to the economic impact of its tax sheltering techniques. Even though the tax amnesty legislation has expired, its passage encouraged companies to be even more aggressive about sheltering money, expecting another holiday in the future, said H. David Rosenbloom, director of the international tax program at New York University. Democrats and Republicans supported the legislation, which passed with sizable majorities in October 2004. ”Congress can swear on two stacks of Bibles that it’ll never do it again,” Mr. Rosenbloom said, ”but they’ve lost their virginity.” With a few narrow exceptions, the drug companies are supposed to be paying as much as 35 percent of their worldwide profits in United States federal taxes. In reality they pay much less. Last year, for example Eli Lilly, the sixth-largest American drug maker, paid less than 6 percent of its profits of $3.4 billion to the United States government, according to its financial statement.

Some rough numbers on Eli Lilly’s profits and income taxes. Last year, its pretax income was $3.42 billion and this story is saying that its US taxes were about $0.21 billion? If their US tax rate was 35%, then their US income was only $0.6 billion with $2.82 billion declared in foreign affiliates. Its total income taxes were about $0.76 billion so foreign income taxes were running around $0.55 billion. The effective tax rate on non-US income was therefore less than 20%, while the overall tax rate was around 22%. It does sound like this company – like a lot of other Big Pharma companies – is parking a lot of profits abroad. And it’s not exactly the case that foreign markets provide more monopoly protection as compared to the US market. So it does seem to be a case where massive transfer pricing manipulation is occurring.

And they get this repatriation on the cheap because of the tax break we gave them a couple of years ago. Why on earth did President Bush and certain members of Congress think that this large tax giveaway would create more American jobs? Were they talking about jobs with tax law firms and accounting firms?