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How to stop big companies from leaving the U.S.

Rick Newman
Daily Ticker
A man walks past Pfizer's world headquarters in New York April 28, 2014. REUTERS/Andrew Kelly

America may have the world’s biggest economy, but that doesn’t mean companies want to be here.

Drug giant Pfizer (PFE) raised eyebrows recently with its plan to merge with British firm AstraZeneca — and move its headquarters to the U.K., to take advantage of lower tax rates there. Such an unusual move makes sense for U.S. companies that earn substantial profits overseas and would pay a “tax penalty” if they repatriated those profits to the United States. The penalty occurs because the corporate tax rate in the United States, at 35%, is one of the highest in the world, which creates a strong incentive to keep profits overseas and pay lower taxes on them.

Pfizer is hardly the first company to pursue such an advantage. In recent years, firms such as Valeant Pharmaceuticals (VRX), Eaton Corp. (ETN) and Horizon Pharma (HZNP) have moved their headquarters outside the United States or made plans to. An investor group is urging Walgreen (WAG) to seek a British address. If the Pfizer deal goes through, other firms could follow. “More companies would do this if they could,” says Martin Sullivan, chief economist with the nonprofit publishing firm Tax Analysts. “If you have large piles of cash trapped outside the United States, you’re likely to be looking for merger partners.”

American companies earned more than $2 trillion in profits overseas last year, much of it declared in low-tax nations such as Ireland, Luxembourg and the Cayman Islands. That tally grows by a couple hundred billion dollars every year. Bringing billions in corporate profits back to the United States wouldn’t necessarily spur a flurry of investment and hiring, since much of the cash would probably be used to boost dividends or buy back stock. But it might lead some firms to spend more on real economic activity, which would clearly be welcome in a slow-growing economy. Here are three ways to encourage big U.S. firms to bring more of their profits back home:

A Congressional awakening. For at least a decade, there’s been serious talk about the need for corporate tax reform that would make U.S. rates competitive with the rest of the world while closing loopholes that allow some firms to pay little or no U.S. tax. Democrats and Republicans even agree, in general, about the need to do this. Yet even though there are tax-reform bills in both the House and Senate, any serious tax reform seems years away at best, for all the familiar reasons: political nihilism, election-year cowardice, etc.

A partial compromise would be a temporary "tax holiday" that created a window of time during which firms could repatriate profits under lower tax rates or none at all. The United States has done that before, but as a one-time maneuver it wouldn't necessarily bring cash home permanently. And this, too, would require Congress to actually agree on a bill and pass it. 

[See related: Corporate tax reform is dead — so why are companies fighting it so hard?]

A higher wall. One proposal that has a better chance than comprehensive tax reform is a plan to make Pfizer-style mergers much more difficult. So-called “inversions” are allowed as long as the firm that results from the merger of a U.S. and foreign company has at least 20% foreign ownership. Congress passed that law a decade ago to prevent U.S. firms from simply moving their nominal headquarters to a low- or no-tax nation, without any other business purpose. Sen. Carl Levin (D-MI) wants to require at least 50% foreign ownership — a threshold President Obama supports — which would require the U.S. firm to give up ownership control.

"The system is tilted heavily toward outside activity," says Chuck Marr of the Center for Budget and Policy Priorities. "The idea is to make the wall to the outside higher."

Levin's proposal may not pass, but it could still dissuade companies from moving overseas, since a retroactivity clause could make the 50% threshold effective beginning at any date in the past. So companies executing an inversion now would be gambling that the Levin bill won’t pass in the future.

Public embarrassment. Most companies abhor controversy and tend to react when faced with boycotts, protests or other types of unwanted publicity. In 2002, Stanley Works (later acquired by Black & Decker) canceled a tax-avoidance plan to relocate its headquarters to Bermuda, after a public outcry. The same outrage seems lacking today, however. Aside from Levin’s forthcoming legislation, Americans seem blasé about the Pfizer move. “The public has just become more conditioned and accepting of this type of behavior,” says Sullivan. It might help that there seem to be other reasons for Pfizer and AstraZeneca to merge, in addition to the tax savings.

There's one other thing that might bring more corporate cash home: A roaring U.S. economy. If big firms were able to earn strong returns on U.S. investments, that might offset the tax penalty and persuade them to bring more profits home. Business spending is tepid, however, since the economy is weak and political brawling in Washington hurts more than it helps. If nothing changes, expect corporations to continue playing hide-and-seek with the tax man.

Rick Newman’s latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.