Money & Politics

How Corporate Inversions and Congressional Gridlock Got Beat

You don't necessarily have to pass a bill to get something done in Washington. How Pfizer's attempt to offshore its profits got stymied.

Beating Tax Inversions and Congressional Gridlock

Flags of US drug giant Pfizer, along with those of France and the European Union outside a factory in Amboise, France. (Photo: ALAIN JOCARD/AFP/Getty Images)

Thousands of bills are introduced in Congress each year that never get a hearing in committee. But now and then, introducing a bill that addresses just a small part of a big problem (an opaque, overly complex and unfair tax code), with the full knowledge that it’s going nowhere, can achieve political, policy and practical success.

America has experienced multiple waves of inversions, starting as far back at 1993, when Texas cosmetics maker Helen of Troy, acquired a Bermuda mailbox.

We just saw that in two bills aimed at stopping multinational American companies from converting profits earned in the United States into tax deductions by moving profits offshore before they are taxed.

One way companies do this is by setting up offshore subsidiaries and then paying them fees, interest and royalties. On corporate ledgers that converts the black ink of taxable profits earned in America into the red ink of expenses, even though the money simply moves from a company’s American accounts to its offshore accounts. 

The practice is known as “profits stripping” and it has exploded since a five-word addition to the tax code, officially numbered Section 532(b)(3). That small change threw the door wide open for American companies to siphon untaxed profits overseas.

A second technique is to move the company headquarters offshore. Nothing really changes. The company rents a mailbox or opens a small office where someone takes in mail and sends out tax documents, while operations continue as usual in America. That’s known as an inversion, one of many terms of art in the impenetrable language known as tax that are intended to defy common understanding.

America has experienced multiple waves of inversions, starting as far back at 1993, when Texas cosmetics maker Helen of Troy, acquired a Bermuda mailbox. Its combined federal and state income tax bill is now just 9.8 percent of profits, not the 37.3 percent it is required by law to report to shareholders.

Both techniques, earnings stripping and inversions, juice profits of companies that employ them, while doing enormous damage to government revenues. Worse, they put purely domestic companies at a disadvantage because they are not eligible for these tax avoidance tricks.

These techniques thus discourage creation of American jobs since the untaxed profits, once moved offshore, cannot be invested here to expand production. There is a small exception, in which companies borrow back some of the money in complicated, short-term internal loans, but that’s not practical for the big, long-term investments that create jobs.

The object with both techniques is to move profits to a place called Nowhere. That’s because Nowhere has no government, no laws and therefore no taxes.

Edward Kleinbard, who was a leading creator of tax dodges for wealthy people before he started exposing the devices and showing how to make the tax laws simpler and fairer, describes profits that escape taxation as “stateless income.” The world is awash in stateless profits.

The bills targeting these particular tax dodges were introduced by two Democratic senators, Sherrod Brown of Ohio and Chuck Schumer of New York.

Brown said he had no expectation his bill would go anywhere. Similar legislation introduced two years ago was also ignored.

The world is awash in stateless profits.

Schumer, likewise, put forth his Corporate Inverters Earnings Stripping Reform Act of 2016, updating his similar 2014 bill. It would cut in half the deduction for any interest paid by any American corporate child to its offshore corporate parent. That would make moving a company’s tax headquarters offshore much less attractive, though it would not stop the practice nor would it affect other payments, like royalties and management overhead fees.

But the two senators joined forces last month. In announcing his new bill Schumer, along with Brown, smartly cast it as a compromise measure, a baby-step towards overall tax reform, long talked about but not done in three decades. Some reform is better than none, they argued.

“While I will continue working to forge consensus on comprehensive international tax reform, we can’t wait to take timely and common-sense steps to immediately put a stop to this egregious practice” of profits stripping, Schumer said.

What the bills did was raise concerns among those standing in the way of real tax reform, largely those lawmakers who depend on the largesse of the companies and investors who benefit from current law. Turn on them and you risk them funding a challenger in the next election who will comply with their desires once you are voted out, a threat made much more likely thanks to the Supreme Court’s Citizens United decision allowing unlimited corporate money in elections.

In this case, however, they didn’t have to.

The rising tide of populist anger over outsourcing, which has candidates as ideologically diverse as Bernie Sanders and Donald Trump expressing sympathy with Carrier Air Conditioner workers who are fighting plans to move their jobs to Mexico, made this an issue that wasn’t going to stay in the great congressional bill cemetery. A video of the Carrier workers reacting to a February announcement of their face has gone viral, with more than 3.7 million views as of this writing.

Take A Look

The alliance of Brown and Schumer, one a full-throated populist and the other the senator who represents Wall Street, was a sign of the political consensus that was building. Soon after Schumer and Brown announced their legislation, President Barack Obama invoked executive powers granted by Congress to make inversions and profit stripping less attractive. It’s not a complete solution, either, but it made the tax avoidance algebra far less lucrative. That move set off less than the usual barrage of partisan finger-pointing, suggesting that lawmakers were happy to have this taken out of their hands.

And then Pfizer, one of the biggest profit strippers, dropped its $160 billion plan to merge with Allergan, an Irish drug company, a move whose only purpose was to pay less American taxes. That came after some Americans, including a few influential editorial pages and broadcast commentators, drew attention to the Pfizer plan and lauded the White House action to make inversions less lucrative.

By the way, Allergan is actually a New Jersey company — it just has its tax headquarters in Dublin, Ireland.

Whether Congress will find the will to enact true tax reform in our lifetimes remains an open question. But this is a case that shows where there’s enough outrage, even a gridlocked Washington finds a way to get something done.

David Cay Johnston

David Cay Johnston is a Pulitzer Prize-winning investigative journalist specializing in tax matters and the author of The Making of Donald Trump. Follow him on Twitter: @DavidCayJ.