Marty Sullivan of Tax Notes magazine has documented the location of profits of U.S. pharmaceutical companies for years. Each article he writes contains eye-popping figures. Last week’s was no different. In the March 8 issue, Marty used annual reports to chart the before-tax profits of seven large U.S. drug companies over the last decade or so. Here’s the story: between 1997 and 2008, foreign profits of Abbot Laboratories, Bristol-Myers Squibb, Eli Lilly, Johnson & Johnson, Merck, Pfizer, and Scherling-Plough quadrupled from about $9 billion to $37 billion. Over the same period, their U.S. profits fell by a third from $17 billion to $11 billion. Bottom line: the share of U.S. pharmaceuticals’ profits earned abroad has grown dramatically—from about one-third in the late 1990s to nearly four-fifths in 2008.
Suppose that a taxpayer earns an additional dollar of income. How much tax would she owe on that dollar? A natural way to answer this question would be to look up the taxpayer’s statutory tax rate – the rate corresponding to her tax bracket and filing status. But that approach often gives the wrong answer and can mislead not only taxpayers but policymakers. Many tax preferences are phased in or out according to income, and as a result, those who earn extra income may face either a hidden tax or a subsidy as their tax benefits change in value. For example, for those in the phase-in range of the earned income credit earning an extra dollar increases the credit and reduces their tax liability, driving their actual rate below their statutory rate. But once they make enough so the EITC begins to phase out, the opposite happens and the rate they actually pay climbs.
President Obama took aim at multinational corporations last May at a press conference on international tax policy. I’ll leave out the details here, lest I put you to sleep or explode your brain. Let’s just say that the current system is a mess that drastically needs fundamental reform. Economists describe two contrasting “pure” approaches to taxing the income U.S. companies earn abroad. A “worldwide” approach would apply our domestic tax rules to all income (with a foreign tax credit to protect against double-taxation). In theory, that system would tax U.S. business income the same, whether it’s earned at home or overseas, so firms shouldn’t care where they invest. In contrast, under a “territorial” or “dividend exemption” system, the U.S. wouldn’t tax active business income earned overseas; American firms would pay only the taxes of the country where they earn income, just like any non-U.S. business operating there. In theory, that puts U.S. businesses that invest abroad on equal tax footing with foreign firms.
Yesterday my colleague Bob Williams blogged on how difficult it will be to dig ourselves out of our enormous budget hole. He examined CBO’s biennial Budget Options report, which contains a list of “revenue options” for modifying Federal taxes. Bob focused on the year with the smallest deficit over the ten year budget window which happens to be 2012. In that year, CBO predicts we will run a deficit of “only” $633 billion. The individual income tax raises the bulk of federal revenues, so naturally Bob looked at incremental reforms of those levies.
During the 2008 presidential campaign, much was made of candidate Obama’s proposal to boost taxes on “high-income” taxpayers. Campaign attack ads warned those folks—couples with income over $250,000 and others with income over $200,000—that a big tax increase was on the way. Joe the Plumber complained that the tax increases would stifle his unborn entrepreneurial dreams.
Recently, Senator Jeff Bingaman (D-NM) and Senator Charles Grassley (R-IA) introduced bills that would discourage private investment in toll roads through public-private partnerships (so-called P3s). Notable examples of this type of investment include the long-term concessions for the Chicago Skyway and the Indiana Toll Road that were granted to private toll road operator-investors.
When President Obama proposed international tax reforms on Monday, the biggest surprise was a provision that would prevent parent companies from making foreign affiliates “disappear” for U.S. tax purposes. How do you make an affiliate disappear? Since I have not taken the magicians oath, I’ll tell you. But here’s one clue: It is perfectly legal under the so-called “check-the-box” rules.
It’s never too early to plan for next year’s taxes. Let’s say you’re thinking about doing some energy-saving home improvements soon and want to know what federal tax credits are available and how they work. How would you find out? You might try the IRS website. I did but, unfortunately, couldn’t find any information about energy credits for 2009.
President Obama announced yesterday that he has asked former Federal Reserve Chairman Paul Volcker to head a new tax reform panel that will make recommendations by December 4th. This is great news. The current tax system is a complicated mess and can’t produce the revenues we will need in the coming years. But there is no reason for Volcker to reinvent the wheel. His panel could start by looking at the work of a bipartisan tax reform panel established by President Bush in 2005. I may be biased, since I served as the staff’s chief economist, but I think we designed a pretty good blueprint.
We graded many of the provisions in the Congressional stimulus bills, but resisted producing a bottom line. New York Times columnist, David Brooks, however, used our grades to calculate an overall grade point average (GPA) in today’s paper. Brooks calculated, based on our grades, that the Senate plan scores a 2.26 and adds that it's "not exactly the kind of report card you’re proud to take home to momma." Using the Brooks methodology the House plan would earn a 2.4. You wouldn't brag about that either.
Last week’s travel section of the New York Times lists the top 44 vacation destinations for 2009. Neither Bermuda nor the Cayman Islands were on the list. And it looks like neither will make the top destination list for the headquarters of U.S. multinational corporations. The “hot” tax haven this year is cool Switzerland. In the last few months, three large U.S. businesses that are currently chartered in Bermuda have announced that they are packing up and moving to Switzerland. Meanwhile, former hot spot, The Cayman Islands, seems to have lost its allure. Two U.S. companies incorporated there have announced headquarter moves to Switzerland and one plans to reincorporate in Ireland in 2009.
U.S. multinational corporations want another tax holiday. (Who doesn’t?). Under current law, U.S. multinational corporations can defer U.S. income tax on profits earned abroad in their foreign-owned subsidiaries until they bring them home as dividends from the foreign corporation to the U.S. parent. The American Jobs Creation Act of 2004 provided them with a “one-time” chance to bring home these profits at a greatly reduced tax rate. Instead of paying the normal rate of 35 percent (with a credit to offset taxes paid abroad), Congress allowed firms that filed a “domestic reinvestment plan” to bring back funds at an effective rate of just 5.25 percent. To get the benefit of the lower rate, U.S. companies could not use repatriated profits from their foreign subsidiaries to distribute cash to their shareholders either as stock redemptions or dividends, so that the money would be available for domestic investment. The argument back then was that the holiday would stimulate jobs and investment in the United States by allowing firms to access profits trapped abroad by the U.S. tax on repatriations. However, this ignored the well-known adage that “money is fungible”—i.e., that if we require companies to reinvest repatriated profits, it will free up other cash that they can redirect as they wish.