The New York Times today reports that pharmaceutical companies are paying corporate taxes at far below the statutory rate of 35 percent and are not creating new jobs for American workers despite taking advantage of an important break on their taxes enacted in 2004.

The 2004 tax break law enacted by Congress and the President shortly before the election included a provision providing an amnesty allowing companies to repatriate offshore profits and pay only a 5.25 percent tax instead of the usual 35 percent corporate tax. The drug companies brought around $100 billion back, used the tax break, and promptly began to lay off American workers.

And it's not like the drug companies have stopped trying to avoid their taxes now. The article says that Eli Lilly paid only about 6 percent in U.S. federal taxes on its profits of around three and a half billion dollars last year.

Part of the problem is that many large corporations manipulate "transfer pricing" which is basically the accounting that must take place when divisions of a corporation that are based in different countries "sell" and "buy" products or services to and from each other. In theory, if an American division of a company buys something from its division in another country, then that purchase can be deducted for American federal tax purposes. The foreign division has revenue and may have a profit, but in theory it's the business of the foreign country to tax that.

The problem is that a drug corporation could transfer its patents and trademarks to a division in a low-tax foreign country with little transparency (a tax haven) and then that division can "charge" the American division for the use of these "intangibles." The accounting can be done in such a way that the American division appears to have no profits after making these payments, and all the profits appear to go to the division in the tax haven.

One approach that would address transfer pricing directly might change how we decide which country gets to tax corporate income in the first place. We could move to a system in which we taxed corporate income based on which country sales are in (or a combination of sales, payroll and assets) since that might be a simpler and more transparent way of apportioning taxes on multinational corporations.

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