Several pharmaceutical and medical device firms have been in the news recently, and not for their latest blockbuster drugs or lifesaving devices. Many of these companies have been pursuing acquisitions of foreign competitors, with the aim of swapping their headquarters for a more tax-friendly home outside the United States.
As it turns out, finding a more tax-friendly home outside the U.S. is child's play. That's because we currently have the most antiquated and uncompetitive corporate tax system of any developed nation in the world. A throwback to the early post-war period of American economic hegemony, the corporation tax structure is now hopelessly archaic in the modern world of global trade and multinational commercial enterprises. The resulting distortion in capital resources has had the effect of incentivizing U.S. firms to invest more heavily in foreign assets and create more foreign jobs at the expense of American workers.
The first income tax levy on companies in this country was enacted in 1909, at a whopping 1 percent of net profits. Today, the rate stands at 35 percent, the highest by far of the major industrialized nations. In fact, the deleterious effects of punitive corporate tax rates are so well understood that most of our economic competitors have slashed their own rates in recent years. According to data from the American Enterprise Institute, over the past 20 years Canada has incrementally reduced its rate from 28 percent to 15 percent, Germany from 50 percent to 15.8 percent, and the former Soviet satellite states of Central Europe from 40 percent to 19 percent.
Meanwhile, the combined federal and state corporate tax rate in the U.S. is higher than all but two nations on earth: Congo and Guyana.
As if that were not enough, Uncle Sam also taxes the foreign earnings of American companies' subsidiaries, unlike most other developed nations. This has led to the astonishing accumulation of nearly two trillion dollars of American profits that are trapped offshore to avoid being taxed away. It is hard to imagine a more puissant incentive for our firms to invest their shareholders' assets in expansion and job creation outside the U.S.
But perhaps the most perverse consequence is the unevenness with which the actual tax burden is realized. Some large, multinational firms with armies of tax accountants and financial engineers are able to utilize legal strategies to mitigate or defer much of their tax liability. While these strategies are legitimate and clearly beneficial to shareholders, they divert scarce resources away from the most productive allocation and thereby distort economic incentives that might otherwise stimulate investment in American factories and jobs. And the system discriminates against smaller firms with predominately domestic operations that cannot effectively shelter foreign earnings.
Interestingly, both political parties agree that the current system is broken and penalizes U.S. economic growth. As always, however, the devil is in the details. Meanwhile with each passing year, billions in American capital and thousands of jobs go overseas and stay locked up there.
Christopher A. Hopkins, CFA, is vice president of Barnett & Co.