Tax Competition: why it is not a good thing

The Tax Foundation is one of those purported think tanks that preaches (I use the word calculatedly) a strong "free marketarian" ideology.  Most of the materials produced come out very anti-tax, anti-government, and pro-big business.  Most of the material makes one want more information about who is really paying the Tax Foundation's bills.

Not surprisingly, the Tax Foundation has now issued a "special report" challenging the Obama administration proposals on international taxation as "a step in the wrong direction" because they "would put U.S.-based companies at a competitive disadvantage in their competition with multinational firms based in other major trading nations."  See Carroll, Bank Secrecy, Tax havens and international Tax Competition, Special Report No. 167, May 13, 2009.

Let's be clear.  When the Tax Foundation argues for tax competition among countries (i.e., lowering of tax rates and losses of revenues in order to attract MNEs from other countries to establish some kind of token presence, usually, in the low-tax country), as it does here, it is not arguing for a policy that benefits ordinary Americans.  It is arguing for a policy that would benefit major multinational enterprises located in the United States, ones that want the protection of the U.S. flag (and its flagships) but not the corresponding burden of helping to pay the price for the stability at home and the armed and diplomatic forces abroad that are so important to US MNEs when they do business offshore.

Similarly, when the Tax Foundation argues, as it does in the email message sending out the report, that the U.S. tax system is "out-of-line internationally" because it "has made no major change in its corporate tax in over 20 years", it is just plain wrong.  When I began practice at Cleary Gottlieb in late 1995, there was a good bit of discussion in the Clinton administration and among congressional representatives about corporate tax shelters and the need to crack down.  Doggett began proposing his economic codification bill, but the corporate lobbyists were able to defeat it, time after time.  There was at the same time quite a long "wish list" of items that corporate lobbyists wanted to see passed in the tax code.  Many in that corporate wish list were  passed by the Bush Administration working with a Republican congress in the  2004 tax bills.  One heard there'd  even been an explicit tradeoff--the Republicans planned to pass their huge individual tax cuts in the 2003 bills (the one that gave the wealthiest Americans tens or hundreds of thousands in annual reductions of tax bills), and then the corporations will get what they want in the 2004 bill.  What kinds of things were passed to favor corporations?  How about the 2004 erroneously named "Jobs Act" provision permitting repatriation of long-held overseas profits at a pittance of the tax rate that should apply?  That was a meritless giveaway for no purpose other than lowering (even further) the already low tax liabilities of U.S. MNEs.  The US MNEs that had been "good" citizens, repatriating their profits regularly and paying at least some share of the appropriate burden, were stiffed by the competitive disadvantage created by this provision for the "bad" citizens.  Companies that had held out and lobbied for the repatriation provision were able to bring back billions with extraordinarily low taxation, and then plan to hold out on any further repatriation until they could get a similar bill passed again in the future.  The bill claimed it would create jobs.  But there was no job creation requirement for getting the low tax rate!  In fact, many of the companies that made a killing out of repatriating large sums at very low tax also laid off workers.  Similarly, the enormous expansion of the expensing provisions under section 179 and section 168 have provided a gigantic tax writeoff for U.S. MNEs--upfront expensing does not comport with the economic decline in value of property and operates as a huge tax cut.  The same is true of the R&D credit and the "manufacturing" deduction. There have, in fact, been a series of provisions that are "tax expenditures" favoring corporations amounting to billions of dollars. All of these things the Tax Foundation glibly disregards.

The Tax Foundation argues too that the OECD harmful tax practices initiative is itself problematic, suggesting that the paltry amendments by various nations to their information exchange problems have addressed the issues.  Not so.  If it were true, we would not be in a battle with Swizterland to force disclosure of names, where the Swiss banks says they can't provide information unless the request is made for specific accounts, but there can't be requests for specific accounts if the swiss banks have served to hide the information from the U.S.  The information exchange provisions that the Tax Foundation suggests are sufficient, in other words, are merely window dressing.  They do not do the job that is needed to prevent wealthy taxpayers from hiding their assets offshore to avoid taxation.

Similarly, the Tax Foundation insists that low tax rates should not be considered a harmful tax practice because it "is a legitimate way to expand a nation's tax base and increase the living standards of all residents."  The latter, of course, is highly questionable in the case of tax havens like Bermuda or the Cayman Islands--those whose living standards are increased are generally the owners and managers of the MNEs taking advantage of the low tax rates to stiff their home country on the taxes due or the various parasitic law firms and others that make millions off of facilitating that stiffing.  Competition between countries for the business of MNEs who treat countries as fungible entities so that they can  pay labor the least and owners the most possible is not a public good.

The Tax Foundation also continues to compound the misrepresentation of the US comparative tax burden by emphasizing the  statutory corporate tax rate rather than the average effective tax rate or the overall tax burden in the US and other countries.  This is problematic for several reasons.  The US statutory rate provides a very misleading picture of the relative tax burden of the US compared to other countries, because of the large amount of subsidy provided to US corporations through tax expenditures.  Moreover, overly aggressive tax planning by large MNEs significantly reduces the corporate tax burden, since these sheltering transactions may not be found on audit or may not be adequately reviewed to find the aggressive position taken, resulting in companies paying taxes on a lesser amount of income than would be the case if the standards for reporting were stiffer and enforcement harsher. In fact, the average effective tax rate on large US corproations that do pay tax is substantially lower than the 39.25% combined national and subnational statutory rate that is cited in the Tax Foundation report.  Additionally, other countries typically have a significant VAT tax as well as the corporate income tax (and often many additional excise-type taxes).   Accordingly, the overall tax burden is very different from that portrayed solely by looking at corporate income tax rates.  The Tax Foundation claims that the same "trends" apply to overall tax systems, relying on its own study that looked at the effective marginal tax rates, and asserts that average tax rates is not adequate, since it disregards the non-corporate sector.  But this argument surely is a strawman--entities have a choice of form in the US.  There are advantages to operating in the corporate form, and a corporation that chooses those advantages should bear a fair share of the costs of providing them (from regulatory apparatus to general law enforcement to defense apparatus).

The Tax Foundation implies that US MNEs pay the high US corporate tax rate on their foreign source income.  However, that disregards the fact that US MNEs actually game the system to use foreign tax credits to reduce their US source income taxation--a reason for some of the rules proposed by the Obama administration.  

Tax competition is merely one more tool in the corporatist agenda toolbox.  It is not a public good, but a harmful result of globalization and the fungibility of money and, increasingly, labor.  Capital owners benefit, but everybody else loses when countries' ability to raise appropriate revenues from the business sector is undermined by tax competition.  

Comments

[Raza]

Couldn't agree with you more, Linda. As usualv- great post.

[Anthony]

"Capital owners benefit, but everybody else loses when countries' ability to raise appropriate revenues from the business sector is undermined by tax competition"

- Very well said.

[Taxrascal]

This creates a pretty interesting issue: where do companies want to put their international headquarters? If they locate it anywhere but the US, they pay taxes based on the business they do wherever they do business; if they locate their headquarters in the US, they pay taxes to the US no matter where they do business.

The supply of labor in the US is good, but it's not *that* good. The result of this kind of behavior is that we all get to feel good about a smaller and smaller number of companies paying their fair share.

(Also, you should avoid using "free marketarian" in quotes, unless you're quoting something they said. If someone wrote that "A Taxing Matter writes from an "anti-business" perspective," for example, it would imply that you identify as an anti-business person, which I don't think you do.)

[LindaMBeale]

Well, Tax Rascal, I think you are oversimplifying in two ways: 1) by assuming that the US worldwide tax system results in more taxes (there is some evidence of US MNEs actually reducing their taxes on US source income because of their global activities) and 2) by disregarding the advantages that US MNEs have by virtue of their US headquarters--as noted in the postings.

Nonetheless, we cannot deny the problem of tax competition--if countries lower taxes in order simply to create inefficient moves of companies from one jurisdiction to another (perhaps even moves in form but not substance), that is unproductive but permits the company to avoid tax, unless there is a counteraction. but the fact of tax competition just means that countries should cooperate to eliminate tax competition; it does not mean that tax competition is a good idea.

I think your stylistic inferences from the use of quotes are too limited--in fact, quotes around a phrase can carry a variety of meanings and are not limited, by any means, to direct quotations. I intended here the stylistic use indicating that the phrase is one that I have invented for describing the ideological approach that is similar to what others mean when they use the label "Reaganomics". But if it confuses, maybe I'll adopt a different style anyway.

[DFMahey]

"...the average effective tax rate on large US corproations (sp?) that do pay tax is substantially lower than the 39.25% ...."

Linda- I think what would be beneficial to me and possible other readers would be a citation like how did you come up with that fact.

[LindaMBeale]

Hi DF. There is much data that is public on the IRS website in the IRS statistics of income publications. You'll want to look at the latest corporate one, and you can come up with various interesting statistics.

[DFMahey]

Linda, I realize there is "much data that is public on the IRS Website..." but if you are going to make a statement of fact you need to be able to support it. I can't find what your support is on the IRS website. At a minimum hyperlink the reference that you make. After all, you are not stating an opinion but relying on your own statement as a fact to reach your key conclusion. I am sure you caution your students on similar types of errors.

[LindaMBeale]

DF--most readers of my blog know that they can find additional information on this in various postings about the various ways that people have tried to assess the relative tax burden of US corporations. See, e.g., "Studies on Corporate Taxes", at http://ataxingmatter.blogs.com/tax/2008/10/studies-on-corporate-taxes.html. As I noted, the IRS statistics of income provide income on corporations by various categories, and anyone can look at particular sectors, types of return or sizes of corporations and calculate from that information the average effective rate. See SOI Tax Stats-Corporation Tax Statistics, at http://www.irs.gov/taxstats/bustaxstats/article/0,,id=97145,00.html.

[Raza]

Adding to Linda's - another way to gauge the effective tax rate is to go directly the firm's SEC filed 10K or annual reports. For example on page 13 of CAT 10K - it can be seen that CAT's effective tax rate dropped from 32% in 2007 to just 24% in 2008. There are additional adjustmens one can perform as Linda has correctly pointed out. There are several agressive strategies that firms engage in from time to time. Linda has written on it quite a bit in her previous posts.

[Raza]

Here is the link to CAT's 10K http://www.cat.com/cda/files/1374332/7/2008%20CFSC%2010K.pdf