Pfizer-Allergan Tax Magic Should Disappear

Not Ireland.

Photographer: Spencer Platt/Getty Images

A tax inversion is a kind of magic trick. Driven by the dysfunction of the American tax code, U.S. companies can merge with smaller foreign competitors, shift their addresses overseas and -- hey presto -- steeply reduce their tax bills.

Hence Pfizer can merge with the much smaller Allergan, maintain its headquarters in New York and yet find itself officially located in low-tax Ireland. This is a legal, rational and fairly popular maneuver. And it's driving Washington bonkers.

QuickTake Tax Inversions

For the second time in about a year, the U.S. Treasury is changing its rules to make such inversions harder. But don't expect these latest efforts to be any more successful than before. Here's a better idea: Congress should make inversions pointless by reforming the corporate tax code. This would also boost wages and growth, slash compliance costs, and attract investment -- while showing, believe it or not, that Congress can sometimes get things done.

The U.S. corporate income tax is, by almost any measure, a failure. At 35 percent, the rate is the highest in the developed world, and the American system is unusual in demanding that companies pay that rate on all income, no matter where they earn it. Yet because businesses can claim so many exemptions and deductions, the revenue yielded has been falling as a share of the economy for decades.

The burden of the tax falls heavily on workers. It encourages businesses to take on debt. It puts U.S. companies at a disadvantage to foreign competitors. And it induces them to spend vast sums on lawyers and accountants rather than on productive investment.

It also leads to inversions. Because companies can defer taxes on foreign earnings until the money is brought home, they tend to hoard cash overseas. This can have bizarre consequences, such as Apple -- a company with roughly $150 billion in cash at the time -- borrowing money to reward its shareholders. It also offers a huge incentive for U.S. companies to get a foreign address and for overseas competitors to acquire them.

The system is so illogical, in fact, that fixing it has become a rare topic of bipartisan agreement. President Barack Obama and House Speaker Paul Ryan have proposed corporate tax overhauls that have more in common than not. Senator Rob Portman has gone so far as to say there's a "remarkable consensus" on the issue -- not a phrase one hears every day in Washington.

There are two sensible ways to approach reform. One is to substantially lower the top corporate rate, while eliminating most of the deductions and exemptions that companies now spend so many billable hours pursuing. The second is to move the U.S. closer to a territorial tax system, in which most overseas earnings are exempt from U.S. taxation, accompanied by better rules to prevent "income shifting" to lower-tax countries and more funding for enforcement.

Either approach would also require measures to hold revenue constant. This complicates the politics, but only a little: Once there's agreement on the basic principle, balancing the books shouldn't be difficult. A better tax code would strengthen American companies, make the U.S. a more attractive place to invest, and put the tax magicians out of business. What's not to like?

To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at davidshipley@bloomberg.net.