It’s Game On for Pharmaceutical Inversions – USA Versus Ireland


In 2004, Congress passed legislation designed to halt corporate inversions being undertaken by large U.S. companies. This legislation has not served its stated purpose, as evidenced by the recent wave of actual and planned inversions—forty-seven in the last decade, with at least nine planned for the next year. Announcements from companies such as Burger King concerning their plans to reincorporate outside the United States (i.e., invert) have led to expressions of concern and anger. President Obama has decried such behavior, and White House press secretary Josh Earnest recently stated that if Congress refuses to act, the Obama administration will look at possible options to respond to “corporate deserters.”

Given the structure of the U.S. corporate tax code under which the IRS taxes worldwide earnings of U.S. corporations, it is economically rational for companies with the means and wherewithal to relocate to countries that have more corporate-friendly tax codes. Specifically, large U.S. multinational corporations can realize substantial tax savings on their earnings if they can redomicile in countries with low corporate tax rates that do not tax the foreign earnings of their multinational corporations (i.e., countries with territorial tax systems).

Insofar as the primary motivation behind corporate inversion is tax savings, it is no surprise that the focus in discussions and analyses of corporate inversions has been on the U.S. Treasury’s potential loss in tax revenue. However, such analysis must account for the tax strategies currently employed by multinational corporations. Many of the largest U.S. multinationals take advantage of the deferral allowance in the U.S. tax code, which allows them to delay paying U.S. taxes on overseas profits as long as they keep those profits abroad. That U.S. corporations avail themselves of deferral is evident in the more than $2 trillion in foreign profits that they hold abroad. To the extent that U.S. taxes are not paid on deferred profits, and will never be paid if these profits are not repatriated, estimates of tax loss associated with inversion are overstated.

This begs the question: if a U.S. corporation can defer payment of U.S. taxes through deferral, why invert? The reason has much to do with the direct and indirect costs U.S. firms incur to defer repatriation of their foreign earnings. For example, U.S. firms may use their deferred foreign earnings as “implicit collateral” to borrow to fund economic activities in the United States, but this financing strategy results in a higher debt burden and higher borrowing costs. They also may use deferred foreign earnings to make investments abroad that provide a lower return than would be available in the United States. Deferred foreign earnings are also not available to finance dividends or share buybacks that benefit the U.S. firm’s shareholders. The failure to return these earnings to shareholders can negatively affect company borrowing costs and share prices over time and has triggered conflict between management and shareholders.

So if the tax revenue argument is overstated, should policy makers be concerned about inversions? We believe that inversion carries with it the very real potential for job loss and that this issue has not received the attention it deserves. The potential for job loss may be particularly acute with inversion undertaken by pharmaceutical companies.

Headquarters jobs tend to be highly skilled and highly paid white-collar jobs. In particular, headquarters functions tend to include firms’ management, finance, and human resources functions, as well as some research and development activities. Moreover, and particularly important for pharmaceutical companies, the geographical headquarters of large firms in certain sectors of the economy can lead to the development of corporate clusters: the aggregation of complementary business, academic, and not-for-profit enterprises that benefit from economies of scale associated with proximity to one another. When the headquarters operation of a U.S. firm shifts from one state to another, the overall employment effects can be detrimental to the state losing the firm, but can create new jobs and economic activity in the new home state. Overall, the impact on the U.S. economy is minimal. But when the U.S. firm moves its corporate headquarters outside the country, the direct loss of the headquarters’ jobs, as well as the impact on overall business clusters that relied on the U.S. headquarters, may be substantial.

In recent years, Ireland has emerged as an attractive locale for U.S. foreign direct investment, and in particular for pharmaceutical companies. Ireland has aggressively courted such investment and touts benefits including R&D tax credits, an educated populace, and a manufacturing infrastructure. Not surprisingly, as Ireland has attracted increasing amounts of inbound pharmaceutical investment, opportunities for industrial clustering have increased. About 120 foreign pharmaceutical companies have plants in Ireland, which has led to the development of research centers and joint projects with Irish universities. These factors suggests that the tax-based incentives to move to Ireland—a 12.5 percent domestic corporate income tax rate and territorial international tax structure—may be accompanied by real economic incentives for the inverted U.S. firms to shift substantial portions of their U.S. headquarters and other employment to Ireland.

Given the overall development and growth of the pharmaceutical sector in Ireland and the accompanying favorable tax environment it offers to U.S. pharmaceutical companies, incentives exist for U.S. firms to use the corporate inversion process to become Irish companies. A movement in this direction by U.S. pharmaceutical companies is unlikely to dramatically change the amount of tax revenues these firms will pay to the United States relative to what they currently pay, because they currently avoid U.S. taxes by taking advantage of the existing tax deferral system. Of equal or greater concern is the likely negative impact on the U.S. economy as highly skilled employment in the U.S pharmaceutical sector is lost and as employment in complementary sectors associated with U.S pharmaceutical companies follows suit.