The Fine Print: How Big Companies Use Plain English to Rob You Blind

by David Cay Johnston

  There are other voices in Washington that favored this. Senator John Ensign (a Nevada Republican not up for election in 2004) claimed that these repatriated funds would be used “to strengthen the financial stability of U.S. companies, for expansion, for new hires and for research and development.” He calls it “common-sense legislation” and predicts “the creation of more than 660,000 jobs [will] result.” Ensign’s jobs estimate was actually the brainchild of Allen Sinai, the economist who founded Decision Economics and formerly was the chief economist at Lehman Brothers. Creating 660,000 jobs would be a huge boost to the economy, providing work for about one in twelve jobless workers. Sinai, the source of Ensign’s numbers, told me his figure is based on history and how many jobs tax reductions have generated in the past. Yet the per job price would be huge. At $455,000 per job, it would take the average American, paying the average 2004 income tax rate of 13.4 percent, sixty-two years to pay $455,000 in taxes. So even if all those jobs materialized, they were not worth anything close to the cost of the corporate tax break. But, for the moment, that was left unsaid.

  So, imaginary lawmaker, which option would you choose? A broad individual tax cut to curry favor with the masses as taught by Reagan and George W. Bush; the second option of no tax cut for anyone because government was already spending much more than it was collecting in revenues; or would you vote for the third option, a highly concentrated tax cut for a few giant companies that supposedly would create jobs?

  This is an essay question, by the way, because you’ll need to explain your reasons for your choice, along with what steps, if any, you would require be taken later to determine whether you made the best choice or even a smart choice.

  Actually, no, you don’t have to answer the question. Congress already did, when a majority of actual lawmakers voted for the corporate tax cut called the American Jobs Creation Act of 2004. The final House bill got yeas from 205 of 221 Republicans, but just 75 of 199 Democrats. In the Senate, 43 out of 46 Republicans and 25 out of 39 Democrats voted yea. (Not all lawmakers voted.)

  Since that decision is fading into history, we can examine its ramifications. I’d tell you what Congress learned, except the politicians forgot to include any requirement to follow up with reports from the companies that got the tax break, so they assembled no data from which lessons could be drawn. But the IRS did make a study from which much is to be gleaned. Multinational companies liked the Jobs Creation Act so much that 843 of them brought home $312 billion that qualified for the deal, escaping almost $80 billion of taxes, according to a report by Melissa Redmiles of the IRS Statistics of Income division. You’ll notice that the amount of actual tax savings was less than the $93 billion estimated, but not so much less that it undermined the basic premise or the promise of many new jobs.

  Much of the money came from tax havens such as Bermuda and the Cayman Islands. Firms that brought home untaxed profits from high-tax countries like Canada and Britain got an extra opportunity to take advantage of the deal because of some technical features of the law.

  What was the money actually used for? That was beyond the scope of the IRS report, but studying the fine print of annual 10-K reports that companies file with the Securities and Exchange Commission yields some answers.

  By far the biggest beneficiary was Pfizer. As soon as President Bush laid down his signing pen the drug maker brought home $37 billion of untaxed offshore profits. It saved $11 billion in taxes, roughly one out of every $7 saved by all 843 corporations.

  Many of those profits were offshore because of earlier tax tricks. When Pfizer scientists saw promise in a new drug, like a bloodstream medication (later named Viagra) that had an unanticipated effect on male staffers, the company sold the rights to the drug to itself in a foreign jurisdiction. A drug in early stages of development has only a small value, so the price to transfer intellectual property offshore from one pocket of a company to another is small.

  When Pfizer brought Viagra to market in 1998, each one of the little blue pills it sold came with a royalty to be paid to the offshore subsidiary that had acquired the rights to the formula. Pfizer listed those payments as an expense on its American corporate tax return, lowering its taxes in America as it piled up tax-free profits offshore. The 2004 American Jobs Creation Act let Pfizer bring those profits and more home at an 85 percent discount with the promise that this would mean more jobs and more research, which is vital to job growth.

  So how many jobs did Pfizer create, thanks to the American Jobs Creation Act? Well, actually, zero. Not one. In fact, Pfizer closed whole factories and fired more than a third of its employees. At the end of 2004 Pfizer employed 115,000 people, but by 2009 the workforce was down to 74,000. So a tax break that was supposed to create jobs instead was followed by the destruction of 41,000 at just one company.

  Pfizer was not unique. Hewlett-Packard brought $14.5 billion of untaxed overseas profits back to America and immediately fired 14,000 employees. Other companies that brought home untaxed profits fired workers, too, though all of them waited until the American Jobs Creation Act was signed into law before collectively destroying at least 100,000 jobs.

  How did Allen Sinai, the reputable business economist who predicted the creation of 660,000 jobs, get it so wrong? Sinai told me his estimates were meant to cover the broader economy, not the companies that got the benefits. He also said job creation did not work out as his economic model predicted because the relationships between corporate cash flow and job growth in the 1990s were not holding in the twenty-first century. Sinai also said he was changing his model so that future analyses would be more reliable.

  So how much of the tax savings did Pfizer plow into expanding research into new drugs? Adjusted for inflation to 2010 dollars, Pfizer spent 7.5 percent less on research in 2006 than in 2004. Pfizer slashed research even more as time passed, except for one year when it rose slightly. By 2009 Pfizer was spending almost 11 percent less on research than in 2004. Had Pfizer just maintained research spending at the 2004 level, it would have spent $3.5 billion more over the next five years than it actually did.

  Research is crucial to pharmaceutical companies. Pfizer in particular needed to spend more on research because its patents on highly profitable drugs were well on their way to expiring. Since 2004 sales of its cholesterol drug Lipitor, which generates a fifth of all Pfizer revenues, fell 7 percent while sales of Viagra softened slightly.

  Buried in the fine print of the Jobs Creation Act is a hard truth: companies were not obliged to spend one dollar on new hiring or expanding research. Instead, corporations could use their tax savings to replace the money spent on existing pay and research. If that sounds to you like an action with all the significance of moving a dollar from your left pocket to your right, your assumption is correct. The way lobbyists wrote the bill, companies could use their tax savings for virtually anything that company executives said contributed to a firm’s ability to retain workers and create jobs. In other words, creating jobs was not a requirement of the American Jobs Creation Act, while destroying jobs was an authorized purpose.

  Let’s look again at the statement from Senator Ensign, a man known not for in-depth understanding of business or economics so much as for his allegiance to right-wing ideology and subservience to big business (as well as for paying off his former chief of staff and the man’s wife, who was also Ensign’s mistress).

  In Ensign’s statement, there were four permitted uses for the tax savings. The money could be used “to strengthen the financial stability of U.S. companies, for expansion, for new hires and for research and development.”

  A vigorous Washington press corps would do well to parse what members of Congress saw in the same way that Cold War-era reporters parsed the Kremlin’s statements. What if reporters had pressed Ensign about whether all of these purposes had to be met or just the first, vague promise of strengthening the financial stability of companies? What if they had asked why the bill did not require the creation of jobs to qualify and inclu
de a look back to take the tax savings away unless more jobs and more research actually occurred?

  What the reporters covering the bill all missed (probably because none of them read it) was that the law did not even specify the United States when it came to creating jobs. Other than a perceptive piece by Joann M. Weiner in Tax Notes, not a single news clip that I can find showed any reporter really understood what the bill contained, as opposed to what politicians and lobbyists said it contained. Weiner, a Harvard-trained economist, figured out that because the legislation failed to specify the United States, creating non-American jobs also was an authorized use of tax savings under the American Jobs Creation Act.

  “The bill was like an accounting report that takes a number out to six decimal places and therefore seems very precise, but when you read the bill it turns out it is not precise at all,” Weiner explained.

  Perhaps the law should have been called the 2004 Destroy American Jobs Act.

  Now, it is true that had the law not passed, these companies might have fired just as many people or even more, but we would also not have handed these companies a windfall of nearly $80 billion in the form of reduced taxes.

  So since Pfizer neither created jobs nor invested in more research that might someday create more jobs, just what did Pfizer do with its $11 billion tax savings? It used it to manipulate the stock market in a perfectly legal fashion. Pfizer bought back every ninth share of its own stock, about 880 million shares between 2004 and 2009. Soon after the 2004 tax break was approved, the Pfizer board approved spending $5 billion to buy back its own shares and in 2006 it increased that to $18 billion in a desperate attempt to prop up its collapsing share price.

  Why would Pfizer do that? Why would it destroy jobs and cut the research spending on which future profits depend to buy back its own shares?

  The real question is this: how else are executives going to make their own stock options valuable if they are not earning real profits in a competitive market? If stock prices do not rise, then the executives cannot get rich. If Pfizer’s board and executives are more focused on finances than on science, the company cannot earn a profit from investing in new drugs. And if the market thinks Pfizer is a lousy investment—which it has been for years—then one way to game the market is to buy back shares in the hope that this will mask the failings of company executives and directors. However, this fool-’em-with-stock-buybacks strategy, financed with the $11 billion in tax savings and the $3.5 billion cut in research, was yet another Pfizer flop.

  Pfizer shares peaked in March 1999 at $48.60 (equal to $67.12 in 2012 dollars). At the start of 2004, Pfizer traded at almost $39 a share, but since then the trend has been mostly downhill. Pfizer shares had lost more than two-thirds of their value by early 2009 despite buying back nearly 880 million shares or 11.5 percent of those outstanding in early 2004. By May 2012 they traded at $22.

  Taxpayers, meanwhile, pay interest on the $11 billion they borrowed to finance Pfizer’s tax break. At 2012 federal borrowing rates, the interest came to $1 million per day. That cost will rise when interest rates go back up again, as one day they will. Whatever the interest rate, the interest expense will continue unless or until the federal debt is paid off.

  Let’s look at another offshore sleight of hand. Bringing money back from overseas does not require special legislation, and it can be done without paying any taxes. The drug company Merck did exactly that in 2009 when it bought Schering-Plough, a much smaller drug company that made the allergy medicine Claritin as well as Coppertone suntan lotion and Dr. Scholl’s foot-care products.

  Buried deep in the hundreds of pages of legalese is the one oblique paragraph of fine print that matters. Below, “Mercury” is Merck; “Saturn” is Schering-Plough:

  Overseas Financing. At the Closing, (a) Mercury will cause one or more non-U.S. Subsidiaries of Mercury (the “Mercury Overseas Subsidiaries”) to lend up to $9.4 billion, in the aggregate (such amount, as determined by Mercury in its discretion, the “Repayment Amount”), to Saturn Holdings BV and Saturn Intl CV and (b) Saturn will cause Saturn Holdings BV and Saturn Intl CV to pay the Repayment Amount to Saturn and Saturn Sub in satisfaction of such portion of the Intercompany Notes as equals the amount of such payment (for these purposes, translating currencies at the spot rate in effect on the date of such payment); it being understood that, for administrative convenience, the Mercury Overseas Subsidiaries may advance the Repayment Amount directly to the Exchange Agent, in which case Saturn, Saturn Sub, Saturn Holdings BV and Saturn Intl CV will issue appropriate letters of direction confirming such payments.

  In plain English, by using Caribbean tax havens (BV stands for British Virgin Islands), Merck brought $9.4 billion of profits parked offshore back to the United States, while escaping $3.3 billion of corporate income tax. From Merck’s perspective, it transferred untaxed profits in its Caribbean accounts to its American accounts without ever having to pay taxes. In doing so Merck cost you money even if you do not use any of its drugs or other products because it shifted this burden on to you. Your cost? About $10 for each member of your family.

  Jesse Drucker, the dogged tax reporter who dug this out for Bloomberg Business News, also reported on a corporate tax conference that showed how executives are taught to think about shifting tax burdens—every dollar of tax the executive’s company escapes paying, the richer it will make the executive.

  John P. Kennedy, a partner at Deloitte Tax LLP, told a November 2010 conference in Philadelphia that escaping taxes could do more to raise stock prices than increasing sales or cutting costs. Kennedy gave a textbook example of how lowering a company’s actual tax rate by two percentage points could boost the stock by two dollars. Then Kennedy addressed the chief financial officers about their personal interest in finding ways to help their companies pay taxes at rates below the 35 percent rate seemingly required by Congress.

  “You may think two bucks isn’t much, but when you’re the CFO and she has 100,000 options, that’s pretty interesting,” Kennedy said.

  Tax Notes writer Martin Sullivan, a former Treasury Department economist, calculated that in 2008 American drug companies reported that about 80 percent of their profits were earned in tax-favored offshore jurisdictions, up from about a third of their profits in 1997. This rapid growth in foreign profits cannot be explained by increasing foreign sales, which during that time grew only from 38 percent to 52 percent of revenues.

  Sullivan has shown that, at least on accounting records, the most profitable places in the world to do business are the Cayman Islands, Bermuda, Ireland and other tax havens. Moreover, in recent years U.S. multinationals’ profit shifting to tax havens has become increasingly aggressive, allowing corporations to enjoy the benefits of making profits in America without sharing much in the burden of maintaining the society that makes those profits possible.

  Suppose, for a moment, that American multinational corporations can persuade Congress to enact another tax holiday. With more than $1 trillion in untaxed profits overseas in 2012, they would save more than $350 billion in taxes. That’s a burden that would be shifted on to you in the form of reduced services or higher taxes, the equivalent of making every family of four in America pay $4,500.

  If a second so-called jobs creation act were to repeat the language of the 2004 American Jobs Creation Act, it would likely destroy several hundred thousand more American jobs while adding to the interest bill that eats up more and more tax dollars. Have you heard of this push for another “jobs creation” tax break? It would be impressive if you have. Legislation about taxes gets little coverage except for the big bills, and even then the significant details, like a “jobs creation” act with no requirement actually to create jobs, often go unmentioned or get a brief and vague mention. As long as Washington journalists are kept busy chasing ginned-up issues of no importance, and a host of corporate-backed organizations make so much trouble for reporters who provide serious coverage that their editors and producers focus on less stressful iss
ues, Washington will remain a piggybank for the political-donor class and a prop for mismanaged corporations like Pfizer.

  This brings us back to that quote that candidate Ronald Reagan loved so much, the made-up one that warned that the rabble would vote themselves the largesse of the treasury and ruin the country. The lessons here are three:

  Reagan got it partly right. There are votes to capture the largesse of the treasury. The votes, however, come not from the citizenry, but from lawmakers whose real constituency is the political-donor class that is energetically mining the government treasury for its benefit. One way to do this is to abuse the English language by, say, drafting legislation whose title describes the opposite of what the bill says, as with the job destruction features of the 2004 American Jobs Creation Act.

  Had Reagan been right, he would never have won election since he promised the voters less, not more, than his opponent, President Jimmy Carter.

  Unless the voters take the time to understand giveaways (such as the Jobs Creation Act) that effectively take from the many to give to the already-rich few, which will require that the news media provide sustained, serious and skeptical coverage, then the loose fiscal policy Reagan warned about will continue to be right on the money.

  20…

  Hollywood Robbery

  Greed is good.

  —Gordon Gekko, Wall Street

  20. You can learn from reading tiny type on a soup can what ingredients you are about to eat. From the fine print of a loan agreement you can learn how much interest you will owe. But movie theater tickets come with no such disclosures, even though these days you are paying more than the price of a ticket to see many movies.