President Obama's announcement of new programs--none taking effect until 2011--to end "illegal overseas tax evasion" and the Treasury Department press release on President Obama's international taxation proposals are generally welcome news. See Zeleny & Knowlton, Obama Calls for New Curbs on Offshore Tax Havens, New York Times, May 5, 2009; Leveling the Playing field: Curbing Tax havens and Removing Tax Incentives for Shifting Jobs Overseas, Treasury (TG-119), May 4, 2009.
Overseas activities of U.S. multinationals clearly have been a significant taxsaver for those businesses. The release notes that US multinationals paid tax at a rate of about 2.3% on their overseas earnings in 2004, and that the 100 largest U.S. corporations have 83 of their subsidiaries in tax haven countries, with nearly one-third of their foreign profits coming through Bermuda, the Netherlands and Ireland. The administration is accordingly proposing changes in two areas--removing tax incentives for shifting jobs overseas and getting tough on overseas tax havens.
And the corporate lobby is already underway. "Bad stuff", says Kenneth Kies--tax lobbyist for some of the most powerful U.S. multinationals like General Electric and Microsoft. It will "hurt U.S. companies' competition with their foreign rivals by increasing operating costs", say the various trade groups like the U.S. Chamber of Commerce and National Foreign Trade Council. It will "cause a lot of pain", says Bush administration functionary Pamela Olson, because companies structured to get the tax avoidance permitted under current rules. Donmoyer, Obama Seeks End of Corporate Tax Break to Raise $190 Billion, Bloomberg.com, May 4, 2009. Marty Regalia at the U.S. Chamber of Commerce claims that the U.S. is the "only major industrialized country which double taxes the overseas earenings of our companies." See Zeleny & Knowlton, NY Times, above. Hogwash. Taxes on foreign earnings are exceptionally low, as the Treasury release points out. And taxes on all earnings end up at well below the statutory rate. So there's no "double tax" on overseas earnings. In fact, foreign tax credits --especially with check-the-box and the elimination of most of the different foreign tax credit "baskets"--permit U.S. multinationals to cross-credit and lower their taxes on U.S. income. Regalia makes the tired old claim that taxation "limit[s] the ability of U.S. companies to compete." That argument is a slide into the abyss of null taxation--companies will argue that US taxes keep them from competing (with whom is hardly ever specified) until taxes are zero. And even if it were a sound mode of arguing, it disregards the fact that US companies don't have to pay VAT in addition to income tax, as many of their competitors must do.
Folks, of course GE and Microsoft are going to object--they've been getting a nice little ride through these tax breaks that have permitted them to make more money going overseas than they would make at home running the same business. There's no reason for Congress to keep tax breaks that encourage companies to offshore their business. And of course companies aren't going to like the fact that their fancy multi-layered tax avoidance structures may not garner them the big tax savings that they enjoyed for the last decade and a half under check the box with deferral. So what. They've been arbitraging the system. The rules were not good to start with, and it's time the extra benefit these companies had, under a corporatist philosophy that has treated their goals as quasi-sacred, came to an end. Let them compete on a level playing field, rather than arbitraging the offshore rules to their managers' and owners' benefit. The idea that paying the 35% corporate tax rate would make them uncompetitive with foreign rivals is also exaggerated. These companies are paying almost no US tax on their foreign profits, and in many cases they are combining the US laws (check the box rules) with fungibility of money (interest expense) to avoid paying foreign taxes as well.
Remember, too, that those profits earned from moving assets offshore haven't benefitted U.S. workers. As Krugman notes in today's op-ed, "falling wages are a symptom of a sick economy. And they're a symptom that can make the economy even sicker." Krugman, Falling wage syndrome, NY Times, May 4, 2009. The ordinary workers are the first to lose when things are bad, and the last to see any increases when things are good. From 2000 to 2007, wages adjusted for inflation fell. (Of course, the rich got richer, with the average top one percentile at more than a million back in 2006.) And jobs are getting slashed steadily, with new hires getting lower wages. New hiring will be an employer's opportunity for paying lower wages. See Annys Shin, U.S. Workers' Wages Stagnate As Firms Rush to Slash Costs, Washington Post, May 3, 2009. The recession is starting to look like a union-busting bonanza for big business, as hotels get unionized workers to accept wage cuts, and the federal government forces the UAW to huge concessions. It looks like Congress won't have the guts to pass the Employee Free Choice Act, but will instead continue to permit employers to dictate how workers organize themselves to decide on whether to have a union. (The media contributes to that--it still refers to the act as "ending" the choice of secret ballots, which is quite simply untrue.) Meanwhile, with lots of US taxpayer funding, the banks have mostly continued outrageous compensation structures (bonuses already back up to 2007 levels), and they haven't even been required either to actually lend money out at reasonable rates or to modify mortgage loans in bankruptcy. The Senate failed to end the banks' ability to game mortgage loans for their own benefit 52-47. As Ariana Huffington, noted, in Why are bankers still being treated like royalty, May 2, 2009, (hat tip to Angry Bear, here), Senator Durbin has called bankers "the most powerful lobby on capital hill. And they frankly own the place." The banks haven't stopped lobbying for their welfare subsidy as middlemen on student loans, and for their welfare subsidy (called the "active financing exception") to the nondeferral of international business income. For more on the problem of wages and unemployment, including as always some useful discussion in the comments section, see Mark Thomas, Paul Krugman: Falling Wage Syndrome, Economist's View, May 4, 2009.
To remove inappropriate tax incentives for pushing assets overseas, the administration suggests reforming deferral rules, closing foreign tax credit loophooles and using savings to make the research and experimentation credit permanent. I'm definitely in favor of the first two, but the last is just another giveaway.
re Deferring most expense deductions. As the release notes, "currently businesses that invest overseas can take immediate deductions on their tax returns for expenses supporting their overseas investments but nevertheless 'defer' paying U.S. taxes on the profits they make from those investments. As a result. U.S. taxpayer dollars are used to provide a significant tax advantage to companies who invest overseas relative to those who invest and create jobs at home." The Obama proposal would defer expense deductions (other than research costs) until matching profits are brought home--an better-than-nothing step, though the right answer would be ending overseas deferral altogether. Interest expense is a particularly useful expense to multinationals currently in this regard, since companies can deduct interest paid to foreign subsidiaries in low-or-no tax countries to reduce the overall tax burden. This would amount to about $60 billion over the next decade.
Research costs shouldn't be excluded from that proposal. Research that is conducted overseas could almost certain be done at home, and there is no reason to continue to provide an incentive to companies to move research and development laboratories offshore. the proposal asserts that there are "positive spillover impacts" in the U.S. economy, but that argument is not convincing. Those impacts do not require that the research be done in the foreign country; in fact, they are likely to be greater if the tax code provides an incentive for research to be conducted in this country. This exception doesn't pass the smell test: one suspects that it is due to assiduous lobbying by Big Pharm, Big Oil and similar industries.
re Foreign Tax Credit Loopholes. The press release points out that the foreign tax credit, which is intended to ensure that U.S. companies with overseas operations do not pay more on their worldwide income than they would pay if they paid only U.S. taxes, actually has been used--with manipulation of rules and aggressive planning strategies, to achieve a lower tax on their U.S. taxable income. (One of the reasons for this, not mentioned directly in the release, was a gradual loosening of the foreign tax credit over the last decade, with the various "baskets" reduced to only two, thus allowing considerable cross-crediting that reduced U.S. multinationals' taxes.) Again, this provides a competitive advantage to U.S. multinationals over U.S. domestic corporations in the same businesses. The proposal would limit the foreign tax credit to the aggregate foreign taxes paid on aggregate foreign earnings, minus any foreign taxes paid on earnings that are not subject to current U.S. taxes.
re Research expenses. This seems rather obviously to be an attempt to buy some credit with the tech and pharm companies that are among the biggest gainers from the deferral and tax credit gambits above and the biggest beneficiaries of the research credit. Take with one hand, and give away (the research credit) with the other. The research credit was originally enacted in 1981 and although it has faced its deathbed several times, business has been lobbying for making the " extension" permanent for years, and it looks like they may finally get it. I think Obama is wrong on this one, and Congress shouldn't go along. The credit covers 20% of research expenses over a "base amount" determined using the percentage of expenses to gross receipts for 1983-1986, plus 20% of certain basic research payments plus 20% of certain energy research. Making it permanent is justified in the release as necessary for stimulating investment, since taxpayers don't know how to factor the credit into decision. That isn't a good enough justification for almost $75 billion of lost tax revenues over the next ten years. End the credit now, and use those tax savings to help make health care reform take place. That would be much better for job creation here at home. Businesses can deduct research expenses just as they always have been able to do. Their uncertainty is no different from every taxpayer's uncertainty about almost every single aspect of the tax law; in that sense, uncertainty should already be taken into account in market pricing, since tax laws change more frequently than any other area of the law.
The proposals for getting tough on tax havens are all good ideas. They include eliminating loopholes for disappearing subsidiaries, cracking down on individual abuse, and increasing IRS enforcement.
re Eliminating disappearing subsidiary loophole. The administration is finally considering how to deal with the "check-the-box" nightmare created in the late 1990s under Clinton, where Treasury made it easier to disregard 100%-owned corporations by making the "check-the-box" election. The " 'check-the-box' rules have permitted US firms to establish sister subsidiaries in a foreign country and in a tax haven, and shift income from the foreign operating business to the tax haven without reporting income to the US for taxation. The proposal would not permit check-the-box elections to disregard certain foreign corporations, and claims that about $86.5 billion would be recouped over the next decade.
re Cracking down on tax haven abuse by individual taxpayers. The "qualified intermediary" (QI) regime for financial institutions to report and withhold on a "know your customer" basis has been abused--the open solicitation of tax evaders by UBS, a QI for US tax purposes, is a perfect example. "Good" financial institutions can still carry on business with "bad" ones without losing their QI status, by relying on the "bad" institution's assertion that there is no US person on a transaction, and US taxpayers can escape withholding by simply claiming not to be a US person. US taxpayers are required to file certain foreign reports, but if they do not do so, the rules make it hard for the US to compel the report or assert penalties (or, for that matter, get information from the banks in banking secrecy jurisdictions). The proposal will assume that financial institutions that are not QIs are assisting tax evasion, unless established otherwise. As a result, a high tax withholding amount would be required for US institutions making payments to such non-QIs, and US persons holding accounts at non-QIs will be presumed to be required to file a foreign bank report disclosing those assets.Treasury could require QIs to ensure that all commonly controlled affiliates are also QIs. Penalties would be increased and the statute of limitation extended to 6 years. QIs would be required to report on the same basis as domestic financial intermediaries.
re Increasing IRS international enforcement. More resources means more IRS employees--800 of them--able to go after offshore tax evasion.
Recent Comments