Transcript of BioCentury This Week TV Episode 204
Terry Haines, Senior Political Strategist, ISI Group
Joshua Smith, Senior Policy Analyst, Economic Policy Institute
Dr. Mihir Desai, Mizuho Professor of Finance, Harvard Business School and Professor of Law, Harvard Law School
PRODUCTS, COMPANIES, INSTITUTIONS AND PEOPLE MENTIONED
Sen. Ronald Wyden (D-Ore.)
Sen. Carl Levin (D-Mich.)
Sen. Orrin Hatch (R-Utah)
Sen. Paul Ryan (R-Wis.)
Chairman Dave Camp (R-Mich.)
National Science Foundation
Organisation for Economic Co-operation and Development
General Accounting Office
Steve Usdin, Senior Editor
ERIC PIERCE: The tax inversion craze -- it will bolster bottom lines in the short term, but could it have long term effects on US innovation? Politicians say America's competitive edge is at risk as more companies seek lower taxes. I'm Eric Pierce. Welcome to BioCentury This Week.
NARRATOR: Connecting patients, scientists, innovators, and policymakers to the future of medicine. BioCentury This Week.
ERIC PIERCE: Corporate inversions involve a company moving its headquarters overseas for the benefits of lower taxes. Corporations increasingly are employing inversions, and biotech and pharma companies are leading the latest wave. The spate of activity has invoked the ire of Congress and has resulted in warnings from both proponents and opponents about the future of US competitiveness, innovation, and jobs.
One camp is calling for radical changes to the corporate tax code. The other is calling for legislation that would make inverting illegal. Up for debate -- whether moving headquarters overseas results in fewer US jobs and lower investment in US R&D, and in turn puts the US at risk as the global leader for innovation in healthcare and other R&D intensive industries.
One positive: inversions could be the lightning rod that drives true tax reform -- something that Democrats and Republicans both agree on. BioCentury This Week asks both sides to justify their claims. Today I'm pleased to welcome Dr. Mihir Desai, Mizuho Financial Group professor of finance and professor of law at Harvard University; Terry Haines, senior political strategist and managing director of ISI Group, and Joshua Smith, senior policy analyst at the Economic Policy Institute.
Gentlemen thanks for coming. I'd like to show you a clip from the tax inversion hearings last month with Senator Wyden. Let's take a look.
RON WYDEN: The US tax code is infected with the chronic diseases of loopholes and inefficiency. These infections are hobbling America's drive to create more good-wage, red, white, and blue jobs here at home. They are a significant drag on our economy and are harming US competitiveness.
[END VIDEO PLAYBACK]
ERIC PIERCE: Mihir, I'd like to start with you. You actually testified at those hearings. What did you recommend?
MIHIR DESAI: Really, two things. The first things is to say that these transactions, while spectacular in some ways, are an invitation to revisit corporate tax reform. And really, in two ways, our corporate tax is way out of whack with the rest of the world.
First, our rate is considerably higher than other countries. And second, we employ a worldwide regime and we try to tax profits around the world. No other large capital exporting country does that. And as a consequence, unsurprisingly, our corporations want to leave.
So the first is this is an invitation to revisit that in a big way. And the second is to say we could do some really bad things, which is we could try to do a Katy bar the door kind of strategy and trap these companies. And that sounds appealing, but in fact, this is the land of unintended consequences. Lot of bad things can happen.
And if you raise the bar -- which is what's being contemplated on transactions that would qualify -- you could end up giving rise to more substantive mergers and even more transactions. And those transactions will feature foreign companies buying American companies. So there were two messages -- let's do something fundamental, and then the second was don't do something silly, that's a short run solution like we did 10 years ago.
ERIC PIERCE: All right, keep the long term view in line.
MIHIR DESAI: Absolutely.
ERIC PIERCE: So you're advocating for a lower tax bracket. We'll get back to that in a little bit. But Joshua, you have a different take.
JOSHUA SMITH: Absolutely, I fundamentally disagree that the reason we're seeing these corporate inversions is because of our high statutory corporate tax rate, which most people know is 35%, and it totally is true that that's much higher than the OECD average. However, the GAO recently reported that the average effective tax rate for large American multinational companies -- profitable ones -- is at about 17%. They really aren't at a competitive disadvantage.
And perhaps Mihir is right that this is more about the worldwide taxation of American corporations, but I don't think the right way to do it is to say that here you can have free reign of your $2 trillion that you've earned abroad. Bring that on home. You never have to pay taxes on it. I don't think that's the right way to go about it at all. When we revisit corporate tax reform, as Mihir wants to do, we really have to worry about the erosion of our corporate tax base. We need this revenue to pay for things here at home, for American domestic investments.
ERIC PIERCE: And we'll get back to sort of how we might fill that gap. But Terry, I wanted to get your take. You know, Joshua, you mentioned that there's an actual rate and then there's sort of the real rate. And this is akin to sort of putting a hand in the dike. The water seems to find its way into another area where you could lower your tax rate. Terry, what's your take on where we stand here with inversions?
TERRY HAINES: Well, there's a lot of different takes. One is that inversions somehow are a vast majority of current M&A deal flow, and that's simply not true. Our own estimates are that there's $2.5 trillion deal flow currently right now, and inversion activity so far this year accounts for approximately 14% of it.
And in terms of the tax arguments, those are future tax arguments, certainly, because if you look at the scoring or estimates of impact on revenue for Senator Levin's anti-inversions bill, that take comes to $20 billion over 10 years. So what we're talking about is a relatively minor hit to the bottom line for taxes. And we're talking about inversions as a relatively small percentage of overall deal flow this year.
ERIC PIERCE: And there's sort of two sides of the equation. There's sort of the tax revenue, which is one issue, but the other side is what Wyden and the Senators are getting at, which is the competitive issue. Mihir, do you see -- we've got about a minute left -- do you see that we have a tax code that is putting the US at a disadvantage?
MIHIR DESAI: I think so in many ways. So as Joshua points out, we have the worst of all worlds. We have a high statutory rate and a medium average rate. So we have all the distortions of a high statutory rate and we're not raising the revenue. And the answer to that is to bring down the rate and have it be in line with the rest of the world.
The more important point, of course, is on the worldwide regime, which is we've come to the point where we demonize the foreign operations of multinational firms, and that's unfortunate. That activity helps domestic growth. And if we want the American worker to have rising wages, the best thing we can do is to reform the corporate tax, have more investment in the US, and allow our workers to be more productive.
ERIC PIERCE: Terry, what's your thoughts? There's a lot of capital that's overseas and we're going to dig into this more in the next segment. But let's think about how we're going to address that in terms of how companies can access those and the cash overseas.
TERRY HAINES: Well, it's important first to note that the short-term political brouhaha that's going on about inversions obscures a larger truth, and the larger truth is both parties are aligned and have been for some time, from the President on down, that the solution to this issue is to lower the corporate top rate, move the United States towards a territorial system, and as Mihir says, make the tax code much more competitive worldwide.
ERIC PIERCE: We're going to have to get right back to that after this next break. So when we come back, we'll discuss whether inversions could lead to meaningful tax reform. But first, here's a look at inversion deals for biotech and pharma companies since 2012.
NARRATOR: You're watching BioCentury This Week.
ERIC PIERCE: We're talking with Mihir Desai, Terry Haines, and Joshua Smith, discussing how inversions could affect the US innovation ecosystem. Terry, I'd like to start with you. We left the last segment talking about how this inversion phenomenon could really serve as a lightning rod for meaningful tax reform. Let's talk about what your take is on that.
TERRY HAINES: Well, I think that's true. And I think it will happen, actually. What you have is -- what you need is three things in order to make tax reform happen in 2015. You need a forcing event first of all. Inversions is turning into that. Secondly, what you need is parties that are in broad alignment with each other. And as I mentioned a minute ago, that's actually the case. Both parties are aligned around the same sorts of ideas here.
And thirdly, what you need is energetic leadership to get it done. And that's going to be true in both parties regardless. If the Senate remains Democratic, the new chairman, Ron Wyden, remains. If not, Orrin Hatch takes the chair -- but Wyden, still, is very important -- and Paul Ryan moves into the chair in the House. These are people that are committed to it, want to make it happen, and have all said that they're interested in tax reform in 2015. And so I believe that it will.
ERIC PIERCE: So I guess the key question is, where does the money come from to fund that gap?
MIHIR DESAI: Right. I too agree that it's -- I'm optimistic about the prospects for reform. So if you couple a rate reduction with a switch to territoriality, that's going to be a revenue loser. So where does the money come from? And I think it comes from two places.
The first is people don't realize that C corporations, which pay the corporate tax, are now less than half of all business income. So we've seen a proliferation of pass-through entities which we should try to tax on some basis. So a relativity small tax on that can fund it.
And then, the second thing is we have the spectacle of corporations reporting large profits to the capital markets and not reporting profits to the tax authorities. That should change. Their capital markets profits should be a basis for taxation as well. Both of those two combined can serve as significant revenue raisers.
ERIC PIERCE: Josh, any concern with what's been discussed here in terms of cutting tax rates and generating additional revenue.
JOSH SMITH: I think it's going to be tremendously hard to do the kind of reform that is being suggested around here and having it not lose a tremendous amount of revenue. Moving to a territorial tax system, lowering the rates -- that's going to be really problematic. And it's going to be hard to make up that lost revenue, and especially, to make it up in a way that's as progressive as the corporate code is today.
Also, that the parties are aligned. What it sounds like is being talked about is reform that would be revenue neutral, that would move to a territorial tax system, that would lower the rates. Not everybody's going to like this. There are going to be corporations that currently pay low effective rates that will end up having to pay more. And they will scream bloody murder if we try to increase their tax bill in an overall scheme that reforms taxes overall. So it's going to be extremely difficult to get everybody to agree, both parties to agree.
The last major reform proposal that was put out was by Chairman Camp. And that was basically laughed at by members of his own party. So serious ideas are going to be extremely difficult to get through with all the stakeholders involved in Congress and outside of it.
ERIC PIERCE: Let me take a libertarian angle. So if Republicans and Democrats are aligned -- we operate in a global economy. Cash flow and investment is going to flow to where it's treated best -- is this really a testament on how the US looks at corporate profits and cash flow?
MIHIR DESAI: Well, certainly, it's true that we are more and more reliant on the world markets. And so we have a system that isn't cognizant of that. And so that's certainly the case.
And then, the second thing to say -- and just in reaction to what Joshua suggested -- it's tempting to think about the corporate taxes being progressive because it's tempting to demonize corporations. But we know, in fact, that the burden of the corporate tax is paid by workers. And it's unsurprising, because it's going to be paid by workers, shareholders, or consumers. And the workers are the least mobile. So in fact, if you want to do something for American workers, thinking about the corporate tax is one of the best things one can do.
And then, the second thing is, on revenue, as Terry mentioned, we don't raise very much revenue from our international tax provisions. We actually raise very little relative to the distortions we see. So that's a reason why, I think, to really revisit this.
In a perfect world, Eric, would we go to a consumption tax, which would be much better and much wiser on many, many dimensions? Absolutely. And that's the first best. But as you know, we don't live in the first best world. We live in the third or fourth best world.
ERIC PIERCE: Mihir, we were talking earlier about how the earlier legislation that was put around thwarting some of these inversions has actually created this new phenomenon of how corporations are adjusting to do a new type of inversion. Talk a little bit about that.
MIHIR DESAI: So the broader lesson is that we live in a global world with a market for corporate control. And so if you're not going to stop all foreign mergers, it becomes a line drawing exercise. So previously, what we did is we said, you can't just do the paper transaction. You have to have a substantial foreign partner.
Well, sure enough, some foreign companies grew up with the explicit purpose of becoming those foreign acquirers. And they exist now. And they are now taking over our US companies. And that's the sense in which it's an unintended consequence, which is, I don't think anybody wants that to happen.
And similarly, if we raise the bar on that it's going to take a couple years. And then, those companies will grow a little more. And they will become large enough to, again, do that. And again, the consequences will be worse. It'll be more likely that headquarter jobs will leave, R&D jobs will leave. So this is really the land of unintended consequences, I think.
ERIC PIERCE: Terry, what are your thoughts?
TERRY HAINES: Well, I think there's -- let's put it this way. What I hear from our clients, generally speaking, is that there's been great frustration with Washington's inability to rationalize the tax code and make it more competitive. I think that's actually caught Washington by surprise, almost in a generational way. Somewhat to our collective shock, we find we're no longer living in a world where United States domicile alone is necessarily preferable.
And the multinational arrangements are gaining much more vogue and lead to much more business benefit. And we're going to have to rationalize our tax policies to deal with that. Otherwise it's going to continue regardless.
ERIC PIERCE: As you point out, we really are in a global economy. And you go back half a century, if you were headquartered in the US, you were getting, probably, 90% of your revenues from domestic customers.
TERRY HAINES: Sure. And Europe produced a confiscatory regime across the board as a means to actually rebuild their countries.
ERIC PIERCE: So Josh, what are your thoughts?
JOSH SMITH: I think, in the long term, there's going to have to be some kind of international agreement. Like you said, we're in this globalized economy where the intellectual property could be based in one country. Parts could be sourced from all over the world. Assembly could be in another country. The final product could be sold, again, all over the world.
What it's really going to take is international agreement about how to divvy up corporate income that's made across the world, and where that income actually gets taxed. The OECD is starting down that path now. But over the long term, that's really what's going to be required.
ERIC PIERCE: Next -- what policies could the US keep to keep its competitive edge? But first, here's a look at how the US stacks up versus other regions on developing new drugs.
NARRATOR: Now back to BioCentury This Week.
ERIC PIERCE: We're discussing implications of tax inversion on the life sciences industry with Mihir Desai, Terry Haines, and Joshua Smith. Josh, let's talk a little bit about what other policies that the US government could put in place to help keep the US's competitive edge in R&D and innovation.
JOSHUA SMITH: I think too often when we talk United States' competitiveness and what the Hill can do to boost it, we talk too much about the tax code, about deductions for research and development and so on. And those tend to be highly inefficient, especially when they're extended every couple years and no one knows whether they're going to last. I think what we should be talking about is what we can do on the spending side of the ledger, whether the government boosts spending for universities to do basic research or for a more explicit subsidy for research and development in the private sector.
Right now, the United States sort of frowns on explicit and industrial policy. But we have it implicitly through the tax code. I think it would make a lot more sense, be a lot more efficient if it were through the spending side of the ledger.
ERIC PIERCE: Terry, what's your take? I know you've got some experience in other industries that are also regulated -- maybe not quite so much as the life sciences. But what's your take on this?
TERRY HAINES: Well, this almost a uniquely highly regulated industry, in no small part because it seeks for a variety of good reasons, but still seeks to dictate outcomes to some extent. To the extent that my past government experience is helpful or useful, it's in the very simple proposition that what government needs to do is certainly fund, certainly be a part, but get out of the business of picking winners and losers. And fundamentally, what you want is you want very well capitalized companies here that are very interested in pursuing research on their own. And if the government wants to lend a helping hand in certain directions, that's perfectly fine. But basically, you want to let market forces play a little bit more here than they do now.
ERIC PIERCE: So you bring up both two points. One is the NIH budget, which has been largely flat for the last five or six years. If you look at corporate R&D spending at big biotech and big pharma companies, that's been on a lower trajectory for quite some time. So is there anything missing to sort of spur growth in both of these areas?
MIHIR DESAI: Well, so I do agree with Josh where the first best thing is to get our universities going. And of course I'm not just talking in my own book, but I believe that. And of course, the NIH and NSF would be valuable places to go. But I do think it's worthwhile thinking about two additional things.
First, we do live in a competitive world, and there is a great deal of portability with patents and R&D, and that can end up affecting us. So the rest of the world has these patent boxes now, which are effectively tax-free vehicles for keeping intellectual property. We should perhaps think about something that would actually address that.
And the second thing, which is specific to biotech and life sciences, is we've seen this incredible run up in share repurchases. And that allocation of capital away from R&D and towards distributions to shareholders has been massive. And I think we should reconsider that. And actually, the rules around that activity -- which sounds technical, but it is actually I think very, very important -- we should revisit that.
ERIC PIERCE: When you say revisit, are you talking about taking a look at what would be allowable in terms of share repurchasing?
MIHIR DESAI: Yeah. Well, right now, there's a pretty much whatever goes, and so it's not clear that we would want that. So as you know, our most innovative companies think that the best thing to invest in is their own stock. And that's going on for a while. And that's both puzzling and a little worrying.
ERIC PIERCE: And that also presents an interesting intersection because you sort have a situation right now where corporate cash is at its highest levels ever. If we're talking about inversion, we're talking about maybe bringing more money into those coffers. Could this present a dynamic, Terry, where you could actually have a little bit of political blowback around whether companies are going to just spend this money to prop up their own stock?
TERRY HAINES: Oh sure. There's a lot of interest in repatriation, but it sort of rationalized treatments. But it's interesting, there is some blowback involved. But there's also a more difficult DC-based problem, which is how to turn that into a money raiser from a tax perspective.
That sounds strange, but when you realize that you don't have to score it for 10-year effects and the 10-year effect is actually you're losing money through repatriation, it's sort of a difficult problem, and it adds a kink to the overall tax reform debate.
MIHIR DESAI: It is also an opportunity --
TERRY HAINES: Oh, absolutely.
MIHIR DESAI: - -in the sense that that repatriation is a windfall in some sense. And the question is, how does that off-shore cash get taxed in a one-time way?
TERRY HAINES: Exactly.
ERIC PIERCE: Coming up, predictions on what Washington will do. But first, how do US corporate tax rates stack up with other industrialized nations? Here are the numbers.
ERIC PIERCE: We're wrapping up our discussion about tax inversion within the life sciences industry. So let's go to our prediction segment. Terry, what do you see happening around tax inversions, around the tax code? And when is it going to take place?
TERRY HAINES: Well, there's a short term and medium term issue. The short term issue, I think, is much more unsettling for the markets than the medium term issue. The short term between now and the election, what you're going to see is this issue politicized -- politicized by both sides to some extent. The call for economic patriotism versus the idea that what we need to be doing is rationalizing the tax code.
After the election, I think -- let me say, before the election, I think very little happens. There will be some efforts legislatively. The administration is now readying to try to do some things to reinterpret the tax code. But the bigger game here is after the election where I think you have a bipartisan agreement that comprehensive tax reform really needs to go forward. And as I said earlier, inversions becomes the driver of that, the thing that really makes it go.
ERIC PIERCE: And one of the things that the politicians are clearly pressing on is the productivity issue, is the competitive issue, is the innovative issue. And is this going to be also in the fray of the discussion? Is that going to get any traction, or is that just mostly pontificating?
MIHIR DESAI: No, I think it's going to become central, because it touches on the central anxiety of our time, which is stagnant wages. And so I think that will resonate broadly. And I'm an optimist and I'm not a political prognosticator, but I see fundamental reform coming after the election. And I hope it happens with a significant change to the corporate tax system, lower rates so, territorial system, and funded in the ways that I described.
ERIC PIERCE: Josh?
JOSHUA SMITH: I would agree with the other panelists. I really don't foresee fundamental reform happening at once. As discussed earlier, it's hard to do corporate reform without it encroaching also on the individual side of the tax code. And there's just too much fundamental disagreement about whether we should maintain revenue neutrality, whether we should actually make some money through reform. And there's just fundamental issues where the parties disagree.
And as I said earlier, when Chairman Camp had a really serious proposal that maintained revenue neutrality for the next 10 years, it basically got mocked by the Speaker of the House of his own party. So I think that there are just too many people who can be upset by their own personal taxes, their own corporate taxes going up. It's going to be really difficult to do any time in the near term or in the medium term.
ERIC PIERCE: One of the other things that we really haven't touched on is a lot of these inversions are also being driven from Wall Street, from the investor side. And in the way this it's being positioned right now -- the corporate management is really unpatriotic, they're taking our jobs overseas -- but a lot of this is really coming from the institutional investors, Terry. Is that what you're seeing from your chair?
TERRY HAINES: Quite a lot of it, yeah. Institutional investors and the lawyers, actually. Wall Street's driven by the creation of value, and so you would expect that, right? And as I said earlier, there's a frustration with the inability of Washington to rationalize a tax code in a way that permits that to be done solely within the United States.
So after years of frustration, investors are starting to look outside. But that's happening across the board. As I say, the number of inversions deals expressed in dollars are really about 14% of the overall M&A deal flow here, so there's an awful lot of this going on and inversions is a subset of it.
ERIC PIERCE: Yeah, so it's not the lightening rod, but they're still -- it represents a smaller but someone significant piece of it.
TERRY HAINES: Yes.
ERIC PIERCE: Well, I'd like to thank my guests -- Mihir Desai, Terry Haines, Joshua Smith. And that's this week's show. Remember to share your thoughts about today's show on Twitter. Join the conversation using the hashtag #biocenturytv. I'm Eric Pierce. Thanks for watching.