Just about everybody working in America agrees that the country's crumbling infrastructure needs more investment. Behind closed doors, though, America's largest pharmaceutical companies probably want the American Jobs Plan to just go away. That's because big pharmaceutical companies have been heavily incentivized to move their profits and manufacturing offshore.
While speaking to carpenters in Pittsburgh on Wednesday, March 31, President Biden explained to the crowd that the $2 trillion infrastructure bill his administration wants from Congress will also "eliminate deductions by corporations for offshoring jobs and shifting assets overseas." Here's why provisions buried in the fine print of the American Jobs Plan could mean trouble for companies that generate most of their profits in the U.S. like Johnson & Johnson (JNJ -0.33%) and AbbVie (ABBV -4.85%).
Image source: The White House.
Unintended consequences
You probably don't realize it, but active ingredients in the vast majority of prescription drugs Americans pay for are made offshore. This problem didn't begin under the previous White House administration, but short-sighted rules regarding intellectual property enacted in 2017 poured more fuel on a fire that was already raging.
Until 2017, the U.S. had the world's most severe corporate tax rate, which inspired a lot of companies profiting from intellectual property to redomicile their patents in countries with lower tax rates. On its face, the Tax Cuts and Jobs Act of 2017 was supposed to encourage high-tech companies to bring high-wage manufacturing jobs back to the U.S. Unfortunately, shortsighted rules in the bill have encouraged U.S. companies to do the exact opposite.
For example, the Global Intangible Low Tax Income (GILTI) rule was designed to prevent companies from avoiding federal taxes by shifting intellectual property to subsidiaries in zero-tax jurisdictions like Bermuda. Unfortunately, the shortsighted GILTI rule allows businesses to use tax payments made outside of the U.S. to offset profits shifted to low-tax jurisdictions, like Bermuda and Ireland. This makes countries with higher tax rates than the U.S. more attractive places to generate income than the U.S. itself.
The Tax Cuts and Jobs Act also contains a Foreign Derived Intangible Income (FDII) provision that was supposed to encourage U.S. companies to retain profits from their intellectual property at home. The FDII provision defines intangible income as profits on foreign sales in excess of a 10% return on a company's tangible U.S. assets. Back in 2017, experts tried to explain to Congress that this simply encouraged companies to build factories outside of the U.S., but the warnings fell on deaf ears.
That's some loophole
It's hard to measure just how beneficial the Tax Cuts and Jobs Act was for America's pharmaceutical industry, but it's clearly working out well. With the exception of Merck, cash flows generated by the industry's largest players have outpaced the sums these companies set aside for taxes.
JNJ Provision for Income Taxes (TTM) data by YCharts.
Repatriating a lot of cash that had accumulated abroad led to some hefty tax bills for Johnson & Johnson in 2018. With subsidiaries in different tax jurisdictions around the world, though, Johnson & Johnson was able to set aside 47% less for taxes over the past year than it did five years ago, even though the amount of cash generated by operations rose 25% over the same period.
AbbVie's operations are generating nearly three times as much cash as they were in 2017, but the company's tax bills have gotten a lot smaller. AbbVie reported an effective income tax rate of negative 36% last year and the company's provision for income taxes made a deep dive into negative territory, thanks to a parade of tax loopholes related to foreign income.
What to do
If President Biden signs the infrastructure bill he's been promoting, it will also raise the corporate tax rate to 28% from the 21% rate set by the Tax Cuts and Jobs Act. Every dollar spent on income taxes is a dollar earned from operations that a company can't distribute to its shareholders, so this bill would almost certainly lead to some stock-price pressure for U.S. pharma companies.
The Biden Administration hasn't been clear about what rewards will be offered to U.S. companies that repatriate jobs that have already been outsourced, and I don't expect much. That means we can be fairly sure that the American Jobs Plan will affect the returns you can expect from your pharma stocks -- but that isn't a reason to start selling. Before you go and dump all your U.S. pharma stocks, remember that this bill's aimed at all companies that send jobs, profits, and intellectual property abroad.
