|Cartoon by Khalil Bendib|
K Street lobbyists haven’t squealed so loudly about proposed changes to the corporate tax code since they lost their three martini lunches. The uproar has drawn attention away from the fact that U.S. multinational corporations enjoy an effective tax rate of just 2.4 percent on billions of dollars in foreign active earnings.
In early May, the Obama administration announced plans to eliminate the advantages that multinational corporations have over domestic corporations when it comes to the tax treatment of reinvested profits. The reforms were part of a larger tax reform package that includes a pledge to step up the government’s enforcement efforts against wealthy individuals and corporations that stash their money in secret offshore tax haven accounts.
Candidate Barack Obama consistently promised to protect U.S. jobs by cracking down on corporate tax havens. At his May press conference he described the current system as “a tax code that says you should pay lower taxes if you create a job in Bangalore, India, than if you create one in Buffalo, New York.”
The U.S. Treasury’s May 4 release details how it would “reform the [international corporate tax] deferral system,” a long-standing system of deductions and loopholes that allows U.S.-based multinationals to delay tax payments on overseas income until the earnings are repatriated.
Many corporate lobbyists expected Obama would repeal the entire deferral system altogether. That fear whipped up enough hysteria to motivate more than 200 large companies—including IBM, Coca-Cola, Caterpillar, Proctor & Gamble, Cisco, GE, DuPont and Eli Lilly—to send congressional leaders a letter objecting to Obama’s proposal weeks before it was even released.
Rather than eliminate the deferral system, however, the administration presented an array of specific measures designed to address some of the more routine (and costly) ways that companies legally shift overseas income to avoid U.S. taxes. In addition, Obama added a proactive concession designed to neutralize his critics: A permanent extension of certain domestic research and development (R&D) tax credits that would facilitate tax planning and stimulate innovation (especially in green technologies), while creating more jobs at home. Overall, the deferral reforms are estimated to recover $210 billion in corporate income taxes, three times the amount needed to offset the R&D credit.
K Street Whining and Designing
Despite the fact that Obama’s plan emphasizes saving U.S.-based jobs, and appeals to populist anger at corporate tax dodgers, it didn’t get much bounce.
Some of the air was taken out by the efforts of former congressman and corporate lobbyist Dick Armey’s FreedomWorks to distract the media’s attention with its pseudo-populist “taxed enough already” (TEA) protests. Meanwhile, the corporate lobbyists’ preemptive objections tamped down support from tax policy leaders on the Hill, leaving the administration open to attack.
Kenneth J. Kies, managing director of the Federal Policy Group, a lead
corporate tax lobbying firm, promised that the fight over corporate tax
policies would be the “largest fight the U.S. multinational community
has this year and probably into the next. … This is bigger than card
check [the bill that would make it easier for workers to organize
unions]; this is bigger than cap-and-trade [i.e., global warming
legislation] and people don’t realize it,” Kies warned.
“Just imagine a world 10 years from now where there are no U.S.
multinationals because they’ve all been bought by foreign competitors.”
Other corporate lobbyists and trade associations chimed in, including the ubiquitous U.S. Chamber of Commerce, the Business Roundtable, and the National Association of Manufacturers, whose whose president and CEO John Engler called the proposals “disastrous.”
Much is at stake for multinationals that use deferrals and other
loopholes to significantly reduce their taxes. For example, the Wall Street Journal reported that 10 of the largest U.S. multinationals
cut their taxes in 2008 by $20 billion by reinvesting $58 billion
overseas. Specific companies that would be impacted by the change
• General Electric, which reportedly lowered its 2008 U.S. tax rate by 27 percent through deferrals and favorable treatment of exports;
• Pfizer, which cut its 2008 effective tax rate by 20.2 percent through offshore deferrals;
• Merck & Co., which cut its effective rate by 11.7 percent; and
• Johnson & Johnson’s, which lowered its effective tax rate by 12.4 percent via reinvesting $4 billion overseas.
“We know we’re going to take on some tough interests,” Obama’s press secretary Robert Gibbs said,
“but the president believes this is a fight we should have, and one
that we can win.” After all, he continued, “fairness is not something
that will put them at a competitive disadvantage.”
grousing by corporate lobbyists may have been over the top, but it was
not unexpected. Yet the weak support the administration received from
many of its most important allies on the Hill pointed to its own
failure to anticipate the furor.
In addition to closing the offshore corporate tax loopholes, the Obama proposal includes plans to:
• Limit the ability of U.S. multinationals to shift income abroad by relocating intangible property;
• Limit current earnings-stripping practices by multinationals that park intellectual property offshore (i.e., at “expatriated entities”);
• Revamp the withholding rules on dividends to prevent avoidance by foreign portfolio investors through equity swaps;
• Align U.S. corporate methods of accounting for inventories with International Financial Reporting Standards (IFRS), which analysts suggest will help broaden the corporate tax base;
• Target oil and gas preferences, including deductions for ordinary drilling costs, recently enacted oil and gas manufacturing deductions, and tax breaks for companies drilling in the Gulf of Mexico;
• Reinstate taxes paid by polluters for the Superfund: the EPA-managed hazardous waste site cleanup program;
• Codify the “economic substance doctrine” that courts have developed to address tax avoidance transactions designed to satisfy tax codes while contradicting their spirit;
• Increase the IRS budget, adding 800 new enforcement personnel.
Senator Max Baucus
(D-MT), the powerful head of the Senate Finance Committee (which sets
tax policy for the Senate), suggested that “further study is needed to
assess the impact of this plan on U.S. businesses,” while Iowa Senator Chuck Grassley,
the committee’s ranking Republican, pledged to support any effort to
crack down on tax abuses. “But if [Obama is] using tax shelters as a
stalking horse to raise taxes on corporations at the cost of U.S. jobs,
he’ll lose me.”
Although Representative Charles Rangel (D-NY), chair of the House Ways and Means Committee (responsible for shaping House tax legislation), welcomed Obama’s plan—not surprising since many of the plan’s provisions were modeled after Rangel’s 2007 tax reform bill—he also suggested a possible compromise: In exchange for closing various loopholes, the Democrats might agree to lower overall corporate tax rates. Even Representative Richard Neal (D-MA), a well known progressive member of Ways and Means, gave the administration’s proposal a cool reception: “We have to keep American companies competitive, and ‘deferral’ is not [tax] avoidance.”
If groups across the ideological spectrum agree on one thing, it is that the Obama plan omitted a key reform: simplified tax codes. Although his press strategy was designed to appeal to popular outrage over corporate irresponsibility and offshore tax haven abuses, the public is unlikely to rally round a list of fairly arcane and technical reforms. By failing to stoke popular support with a clear plan, Obama has for now effectively left Congress little choice but to dicker over the details.
Obama has “bought into the Washington idea of mucking up the tax code with gimmicks” designed to satisfy one or another constituency wrote ace tax reporter David Cay Johnston in Tax Notes.
Framing the Corporate Tax Debate
In 2008 some 15,000 registered lobbyists spent more than $3.25 billion influencing the U.S. Congress. Corporations were represented by many of most wealthy and powerful among them.
The sheer power of the multinational corporate lobbyist is one reason why the corporate tax debate has been distorted for decades. For instance, the standard gripe among corporate lobbyists and their allies—that U.S. corporations pay the highest taxes in the developed world—is a canard that regularly goes by unchallenged in congressional committee rooms and the many quasi-academic roundtables where corporate tax policies are discussed.
In fact, while the statutory corporate tax rate is 35 percent, most corporations are effectively taxed at much lower rates because of the many loopholes and exemptions their lobbyists have carved into the tax code. Corporate lawyers, accountants, bankers and consultants have created an entire financial engineering and tax planning industry around specific provisions of the corporate tax code, such as transfer pricing.
For example, the Big Four accounting firm Ernst & Young alone has more than 900 partners in its offices around the world working on this scheme by which corporations use intra-firm transactions to reduce their profits in high-tax jurisdictions. Experts estimate that transfer pricing alone costs the government at least $50 billion in lost revenues each year.
The result is that, while the statutory rate may be 35 percent, in 2004 (the most recent year for which data was available) large corporations paid an effective rate of only 25.2 percent on domestic income, according to the General Accounting Office (GAO). Moreover, most large multinationals pay far less. In January, the GAO reported that U.S. multinationals paid just $16 billion in U.S. taxes on $700 billion of foreign active earnings in 2004—an effective U.S. tax rate of just 2.4 percent.
The question of whether corporations are paying their fair share cannot be answered simply by examining statutory or effective rates of taxation. Any calculation must also consider the other side of the ledger: the various benefits, contracts, foreign assistance, loans and other forms of corporate welfare that corporations receive from governments—that is, taxpayers—not to mention extraordinary disbursements such as the recent banking, auto industry and other corporate bail-outs. (Neither the Bush administration nor the Obama administration required public disclosure of the companies’ books – including their offshore subsidiaries—as a condition of the bail-out.)
In fact, as measured by the OECD, the United States collects less in corporate taxes as a percentage of GDP than most other industrialized countries, despite claims to the contrary. In 2007 (the most recent year for which the Congressional Budget Office has data), corporate income taxes totaled $370 billion—or 2.7 percent of GDP. The Congressional Budget Office projects that, “as a result of a projected decline in taxable profits as a share of the economy, corporate receipts relative to GDP [will] weaken steadily … reaching 1.7 percent of the economy in 2017 and 2018.”
One of the key ways multinationals achieve this low tax rate is by operating many “brass plate” subsidiaries (i.e., paper-only companies with no real physical operations) in one of dozens of offshore tax haven and bank secrecy jurisdictions. The GAO reported in January that 42 of the 100 largest U.S. corporations structure their operations to make use of subsidiaries located in at least ten different tax havens. Certain locations are especially popular, including the Cayman Islands, where the GAO discovered 18,000 corporate subsidiaries at one address.
There are clear links between the large numbers of tax haven subsidiaries and the decline in corporate taxes, says Martin Sullivan, a tax economist and author of “Multinational Corporations, Individual Tax Evasion & Offshore Tax Havens” (2008). Multinationals have lowered their foreign taxes further than other large companies by shifting foreign source income from places where they have real investments to low-tax jurisdictions. “The lion’s share of income shifting is tax-motivated,” says Sullivan, who adds that multinationals’ increased use of offshore tax havens threatens to push the entire U.S. corporate tax system toward “breakdown.”
Without a major course correction and bold new initiatives, Sullivan and others say, it may not be long before corporations effectively pay no taxes at all. That outcome would be consistent with the accelerated rates of globalization and concurrent declines in the rate of corporate taxation. According to the Center for Budget and Policy Priorities, the 25 percent effective rate of corporate taxation in 2004 is down significantly from the 33 percent average rate that corporations paid in the 1970s, the 38 percent they paid in the 1960s, and the 49 percent they paid in the 1950s.
Real Change, Not Chump Change
“It will take time," Obama told a May press conference, “to undo the damage done by decades of corporate tax avoidance and a system designed to give multinationals an advantage over domestic industries.” When he introduced his deferral tax reform proposals at the May 4 press conference, Obama described them as a “down payment” on a broader reform agenda that will be taken up after his other priorities, especially health care and energy/climate change.
Nevertheless, although Obama has directed his tax policy advisory group (chaired by ex-Federal Reserve Chairman Paul Volcker) to consider any approaches to tax policy—except directly raising taxes on families making under $250,000 a year—there is little talk of reversing the decades-long decline in corporate taxes. Nor are there indications that the administration will go farther than a transaction-by-transaction approach to corporate taxation.
Some interesting proposals for reforming the tax code have recently come from some unlikely places, including Mark W. Everson, one of George W. Bush’s IRS commissioners (2003 to 2007). In a Washington Post oped in October, he suggested that, rather than embarking on a prolonged battle over arcane regulatory schemes that the public cannot understand, the Obama administration should be pushing for easy-to-understand measures that stand on clear principle, such as a requirement that corporate tax returns be made available to the public.
“Making corporate tax returns public would signal that we are serious about reform and would help rebuild worldwide confidence in American businesses and financial institutions,” Everson wrote. “At a minimum, Congress should not allow businesses to participate in taxpayer-funded bailouts unless we taxpayers can assess who we’re signing up with. After all, Americans routinely provide copies of their federal tax returns to financial institutions before they give us money. Shouldn’t entities looking for taxpayers’ help do the same?”
Another proposal comes from a senior adviser to the Tax Justice Network, a global coalition of NGOs and tax policy experts that focuses on an international approach to offshore tax havens. Richard Murphy, external research fellow at the Tax Research Institute at the University of Nottingham, suggests that the time has come to replace the current approach to multinational corporate taxation with a consolidated international approach. That approach would involve an agreed-upon formula for apportioning the commercial activities to be taxed among different sovereign jurisdictions, much like the territorial system used among the different U.S. states with respect to corporate income taxes.
Although governments are not likely to adopt this idea soon, the increased attention to the question of offshore tax havens at the G-20 and among OECD countries in general suggests that with strong support from NGOs and other members of civil society, a global treaty on consolidated corporate taxation may eventually be possible.
Until bolder measures are introduced and debated, however, what “we can” do at home besides push Congress to close the many tax loopholes designed to exclusively benefit multinational corporations is unclear. In response to questions about the administration’s tax reform plan, Gibbs suggested that Obama will be “happy to have a long discussion about the fairness of tax havens and tax loopholes that let companies avoid paying their taxes.”
Given the current perilous state of the economy and the ongoing exodus of U.S. jobs and tax dollars, the administration will have to do a lot more than that.