Tuesday, November 24, 2015

Inversions, ethics, and national welfare

Today's NYT reports that, in phone calls to lawmakers and Obama Administration officials defending the Allergan deal, Pfizer's chief has been arguing that the deal, by significantly reducing the company's tax obligations, will "give it more cash that it could invest in the United States and ultimately add jobs."

Unless he is parsing his words awfully carefully via the distinction between "could" and "will" add more U.S. jobs, this is almost certainly false. Despite all the cash that they've stashed abroad and don't want to bring home (at least directly) for tax reasons, I very seriously doubt that Pfizer is cash-constrained with respect to U.S. investments that it would like to make.

The only sense in which the suggestion that Pfizer may invest more in the U.S. post-inversion (possibly adding jobs - which is not to say that overall U.S. employment or wages would be higher than otherwise) is as follows. If Pfizer's enhanced capacity, post-inversion, to strip profits out of the U.S. through intra-company financial transactions lowers the effective tax rate that they anticipate facing on marginal U.S. investment, this  would increase the company's incentive to engage in economic activity in the U.S. But on the other hand, it's possible that some or all of their increased U.S. investment (if any) would come at the expense of investment by purely domestic companies that can't use Pfizer's cross-border tax planning techniques to lower their U.S. tax burdens.

Pfizer, obviously, is doing what's good for Pfizer - be it the management (and/)or the shareholders. Note, however, that these two groups' incentives are not necessarily the same. For example, managers may like larger empires, or over-paying for a  chance to boost accounting earnings per share, and may not mind, to the same extent as the shareholders, causing gain recognition at the shareholder level. It's therefore interesting that, according to the Times article, both Pfizer's and Allergan's stock prices fell upon announcement of the deal.

A natural feature of the political economy landscape of these public deals is that politicians denounce what's happening. Again per the NYT article, Donald Trump is only blaming "politicians," but President Obama has previously called such deals "unpatriotic." (Hillary Clinton is quoted as saying just that it shows we need to change the rules.)

People like me are expected to scoff, and to a degree I do, about criticizing company officials for acting on the incentives that the system actually gives them. It doesn't come as a surprise that companies will invert if this gives them the opportunity to reduce their U.S. tax bills. In that sense, the only potential ethical problems that I would see in this general area are (a) any pursuit of managerial self-interest at the expense of their duty to benefit shareholders, and (b) any effort to go beyond what the law, as correctly interpreted, actually permits, counting on deception or the "audit lottery" (not likely to be a factor here) to get away with results that aren't actually permissible.

That said, I wouldn't feel great about myself if I spent my time, and such expertise as I have in tax practice, working on deals like this for high pay, even if the deals clearly were (or could be made) legally valid. It's not how I'd want to spend my life, and I might feel embarrassed telling people about it (or defensive if they viewed it negatively). But that's a personal choice - and one that, who knows, I might have made differently had my opportunity set 30 years ago been different - and I don't insist on it for everyone else.

Also, just because I myself might view it as a bit naive to cast the issue in terms of the "patriotism" of Pfizer's (Scottish-born) CEO doesn't mean that politicians who favor legislative action to discourage inversions shouldn't be saying it. Political debate is often, on all sides, expressed in spurious or at least simplistically moralizing terms to increase its salience and political appeal to a public that, in effect, is watching (or not watching) from the bleachers eight miles away. So an effort to change the applicable rules in ways that I might support inevitably is going to be cast rhetorically in these terms. Needless to say, there is certainly plenty of political rhetoric that is far worse being issued every single day in the 2016 presidential campaign.

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