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The U.S. Isn't Better Off for Killing the Pfizer Deal

Leonid Bershidsky is a Bloomberg View columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.
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The U.S. government's latest moves to prevent the $160 billion Pfizer-Allergan tax inversion deal, and future ones like it, can make the U.S. market unattractive to legitimate foreign investors. The administration uses the U.S. market's enormous size to browbeat companies into submission. Size alone, however, can only motivate investors to a degree. 

In its zeal to stop Pfizer from formally taking over Ireland-based Allergan, President Barack Obama's administration hasn't just made it harder to qualify for an inversion deal, which allows a company to change its domicile from the U.S. to one with a more favorable tax climate. It has also proposed measures against what's known as earnings stripping: borrowing overseas by a U.S. subsidiary and using its U.S. profits to repay the loans, thereby avoiding U.S. corporate tax. The Treasury Department proposes that the debt be treated "as stock," and payments on it as taxable dividends, unless it's incurred "to fund actual business investment, such as building or equipping a factory." 

Tax Inversion

This means foreign investors will have to prove to U.S. tax authorities that their investment, made in the form of debt -- the most common form of foreign investment anywhere, not just in the U.S., because of the tax implications -- is legit and not made for the purpose of avoiding taxes. 

U.S. investors would rebel if faced with such a rule change in any country where they operate. And foreign investors in the U.S. economy aren't exactly silent, either. Nancy McLernon, president of the Organization for International Investment, which includes many of the big non-U.S. multinationals operating in the American market, said in a statement:

The Administration’s sweeping proposal will increase the cost of investing and across the United States for all foreign companies and put at risk more than 12 million American workers that are supported by foreign direct investment in the United States.  This is a misguided approach that could have a freezing effect on attracting global employers and will damage U.S. competitiveness, which may very well be measured in lost jobs, wages and GDP.

None of the big investors, of course, will contemplate leaving the U.S. market: It's too huge for that. Members of the Organization for International Investment typically make a significant share of their revenues in the U.S.

So far, the U.S. market has generally treated these companies fairly, helping them reap comparable shares of their total profit from their investments. Fairly, that is, barring unpleasant surprises, like BP's oil leak debacle, Volkswagen's "clean diesel" scandal or BNP Paribas' sanctions violation case. In all these cases, the U.S. has extracted or is attempting to extract higher penalties than any other country would have dared to demand. In a smaller market, rather than pay billions of dollars in fines, a company might prefer to place its subsidiary under bankruptcy protection and perhaps even exit. Nobody, however, wants to mess with the U.S. -- foreign investors weep but pay up (though Volkswagen, which is less dependent on the U.S. market than many of its peers, may yet make a beeline for the exit if pressed too hard by U.S. regulators and litigators).

What will happen, however, if U.S. profit shares start falling behind revenue shares? The same as in any other country: Investments that promise a better return will become a higher priority. That is already happening to some degree.

Until 2010, the U.S. was the biggest magnet for foreign direct investment in the world, unless one counts the European Union as a single entity, but then China overtook it, and now India has a shot at beating it, too. After a period of quick growth in the 2000s, foreign direct investment in the U.S. has been stagnating:

Inversions are one of the hottest political issues in the current presidential campaign, and it's a rare one on which both parties agree. Donald Trump has called the Pfizer-Allergan deal "disgusting." Both Democratic candidates, Hillary Clinton and Bernie Sanders, have voiced indignation about it. It's important for the Obama administration to steal Trump's -- and Sanders's -- thunder. 

Is it more important, however, than maintaining the increasingly shaky perception of the U.S. as the land of opportunity for global investors? If they don't feel welcome because of the tightening regulation and the growing risk of doing business in the U.S., Americans can hardly benefit. EU citizens certainly didn't when foreign investment went down sharply after the global financial crisis and never recovered: Unemployment levels in most European countries are still abnormally high.

Making it impossible for Allergan to show it will control more than 20 percent of the combined entity -- which was the purpose of the first part of the Treasury Department's proposal -- would have been enough to derail the politically odious deal and make it clear that the Democratic Party is not beholden to Big Pharma. Making it harder for multinationals to invest in the U.S. market is not a good way to compensate for its failure in cleaning up the country's corporate tax code.

Paradoxically, restrictive measures that can only stand because of the U.S. market's size are signs of weakness, not strength. The next administration will need to do better at fighting the root cause of inversions -- tax regulations that make the U.S. uncompetitive with the countries to which companies such as Pfizer would like to move their offices.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Leonid Bershidsky at lbershidsky@bloomberg.net

To contact the editor responsible for this story:
Therese Raphael at traphael4@bloomberg.net