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June 2012
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EXODUS Punitive taxes causing top firms to leave U.S.

This week's award for understatement goes to a U.S. Treasury official who spoke last week to a conference of The Wall Street Journal's CFO Network. Addressing the proliferation of 'inversions" to become foreign companies - particularly in the U.S. biotech field - Deputy Treasury Secretary Sarah Bloom Raskin told the group the trend indicates "something is probably wrong with our tax system."

She added, "This is a signal that some sort of business tax reform should be taken quite seriously."

Unfortunately, the Obama administration's idea of reform is to tighten the rules on U.S. companies doing inversions in hopes of squeezing another $17 billion out of them over the next 10 years.

If you have not followed the issue, "inversions" are a type of corporate merger that allows a U.S. firm to reconstitute itself as a foreign entity. The trend is being driven by the U.S. corporate tax rate, which at 35 percent is among the highest in the developed world. In a parallel trend, U.S. companies have been hoarding cash they have made abroad to avoid the punitive U.S. taxes. Inversions are a way for them to put that money to work abroad while at the same time lowering their tax rates to those of countries like Ireland, where they pay about 17 percent on average.

A story earlier this month in the Financial Times notes that the top 14 U.S. drug and technology companies alone have $500 billion in cash they've parked abroad to avoid the punitive U.S. taxes. The FT found that those 14 companies paid an average overseas tax rate of just 10 percent last year, and that their overall tax rates fell over the past eight years even as their foreign profits grew at three times the pace of their foreign sales.

There is nothing illegal about this. And there is nothing wrong with it. Companies have a legal duty to act in the best interests of their shareholders, and that means taking the steps necessary to maximize profits. U.S. corporate tax rates are simply not competitive, and the earnings capital of U.S. corporations is more than welcome in other countries, even as the U.S. builds walls to keep it from returning home.

A hostile U.S. tax code is actually having two effects here. It is causing corporations to recognize and hoard profits abroad rather than investing them in the U.S. or paying them out as dividends to U.S. shareholders (rather, some companies are taking on debt to pay dividends while keeping excess cash abroad). And it is creating an incentive for U.S. companies in some of the richest fields - technology and pharmaceuticals - to merge with and thus become foreign entities.

Medical device giant Medtronic took the latter path just more than a week ago, announcing it is buying Ireland's Covidein PLC for $42.9 billion and saying unabashedly that inversion tax benefits drove the transaction. Pfizer, maker of such drugs as Lipitor and Viagra, attempted to do the same last month with a $120 billion offer for AstraZeneca in the UK. That offer was rebuffed however.

These companies are not making these moves because they are anti-American. They are doing so because U.S. tax laws are anti-business, making it more difficult for them to compete on the global stage.

We suspect that the U.S. companies hoarding cash abroad and those contemplating inversions would far prefer to remain U.S. companies and to invest their excess cash in domestic undertakings. But it is going to take a change in Washington - both in attitude and the tax laws - if that change is going to materialize.

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