Pfizer is the largest drug maker in the United States, but after striking a deal on Monday to buy Allergan, the company is on the verge of becoming Irish.
For shareholders, this may be their lucky charm. After the merger, Pfizer will be able to shift its legal headquarters from New York to Dublin and pay lower taxes, which should bolster its bottom line. But in the process, scientists are likely to lose their jobs, innovation may suffer, and consumers could pay more for Pfizer medicines.
This is often true of many large takeovers in the pharmaceutical industry as companies look to slash expenses and quickly appease investors. In this case, about $2 billion in cuts are planned. But the type of deal Pfizer is pursuing, which is known as a tax inversion, appears destined to accentuate the downsides.
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An inversion is a sophisticated piece of financial engineering in which a US company buys a foreign firm, and then moves its headquarters to an overseas location where corporate taxes are lower. Faced with declining sales, Pfizer pursued its $155 billion deal — $160 billion including debt, the largest ever in the pharmaceutical industry — because Allergan’s legal headquarters are in Ireland. The corporate tax rate there is 12.5 percent, compared with 35 percent in the United States. But Pfizer won’t see as much benefit as that stark gap would imply; it expects the deal will drop its tax rate to about 17 percent from 25 percent today, owing to the variety of jurisdictions where Pfizer operates.
The lower tax burden helps explain why inversions have been especially popular among drug makers. But such deals can be little more than desperate attempts to patch over strategic shortcomings.
“Here’s the problem: Instead of a culture of discovery and innovation, the accountants are in charge and you better do whatever they say,” said Stephen Brozak, an analyst who heads WBB Securities and tracks the pharmaceutical industry. “It’s not about breakthrough medicines. It’s a stop-gap measure, because all it does is play with tax codes so the financial numbers look better.”
Americans can expect to lose out in different ways. As drug makers consummate their deals, they come under intensifying pressure from Wall Street to meet financial goals. As a result, their tactics can include goosing revenue by raising prices on their medicines. Plus, as with any large merger, some facilities and product development will inevitably get shut down, costing jobs and ending research programs.
In recent years, Pfizer has shuttered key research facilities and laid off thousands of scientists in the United Kingdom and Connecticut. Although the combined company will have a large budget for drug discovery, research and development might not be a high priority. Allergan chief executive Brent Saunders, who will assume the number two job after the merger, has previously pooh-poohed the idea that discovering drugs can generate a sufficient return for investors.
Paying lower taxes can yield that payoff, however — and the Allergan deal makes this still easier by completing an ongoing effort by Pfizer executives to move the company’s revenues offshore. “They are already one of the best tax dodgers in America,” said Frank Clemente, who heads Americans for Tax Fairness. The advocacy organization pointed out that Pfizer hasn’t paid taxes over the past five years. Meanwhile, the company has parked about $148 billion overseas, none of which is taxed in the United States.
According to a Pfizer spokeswoman, some of those funds are periodically repatriated stateside to fund research efforts. But until that happens, the money remains out of reach of the US Treasury Department — and this is not good news for the US economy or American taxpayers. In fact, the inversion will give Pfizer access to that overseas cash without the US tax bill.
“The average American is disadvantaged because tax revenue goes down and somebody has to pay for that,” said Samuel Thompson Jr., who heads the Center for Mergers and Acquisitions at Pennsylvania State University. “But if a company can reduce its tax rate on income, shareholders will benefit.”
Despite growing outrage, Congress has not taken any steps to change the tax code. Twice, the Treasury issued rules to slow the trend: Last year, the department did so after Pfizer unsuccessfully tried to take over AstraZeneca, which is based in the United Kingdom; and the most recent effort occurred Thursday as Pfizer and Allergan were racing to complete a deal.
On a conference call with analysts on Monday, Pfizer chief executive Ian Read appeared to brush aside concerns about political risks. Nonetheless, Read sent a letter to Mitch McConnell of Kentucky, the Senate majority leader, hoping to reassure lawmakers that the combined company will have numerous US facilities and the deal will be “good for patients and US competitiveness.”
Of course, a lower tax rate is no guarantee that Pfizer — or any company that pursues a tax inversion — will ultimately make more money for shareholders. In the short run, some of the biggest winners are the investment bankers and lawyers who profit from working on these transactions.
Ultimately, the only way to really thwart tax inversions is to change the tax code. But so far, Congress has not shown a willingness to do so and it remains unclear if that will change anytime soon.
Until then, we may witness drug makers concoct more tax schemes than new medicines.