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Thursday, November 10, 2011

Mississippi's Eminent Domain Reform Initiative Passes with 73%

While national attention focused on the defeat of the "personhood" initiative in Mississippi on Tuesday, voters there approved Initiative 31, an amendment to the state constitution that bans the use of eminent domain to transfer property from one private owner to another (h/t Jim Roos, Missouri Eminent Domain Abuse Coalition) with 73% of the vote.

Eminent domain, where government takes private property for public use, is regulated by the Fifth Amendment to the Constitution, which says, "...nor shall private property be taken for public use, without just compensation." The issue of what constitutes a "public use" has been expanded by court decisions over several decades, with the U.S. Supreme Court's 5-4 ruling in Kelo v. City of New London that economic development qualifies as a public use, even when the property is being transferred to a different private owner.

Eminent domain is heavily entwined with economic development subsidies, in particular tax increment financing. Removing "blight" is often a reason a government can resort to eminent domain, and some variant of blight must be shown in most states to allow the use of tax increment financing. I argued in Competing for Capital that fighting subsidies often attracts "strange bedfellows" coalitions, because they can be criticized on efficiency, equity, and environmental grounds, potentially pulling opponents to subsidies from across the ideological spectrum.

For similar reasons, we see unusual political coalitions fighting private-to-private eminent domain. For one thing, these cases usually involve subsidies, as did Kelo. People understandably don't want to lose their homes, but they are especially incensed if they are losing their homes to enrich a company or private developer. Moreover, such cases can heavily impact minority communities (if property values are lower there) and small businesses (especially if compensation only takes property value into account, but not the value of the ongoing business). In Mississippi, the Southern Christian Leadership Conference and the National Federation of Independent Businesses filed a joint amicus brief with the state supreme court to keep Initiative 31 on the ballot, represented by the libertarian Institute for Justice. Talk about strange bedfellows!

This coalition can break down, however. As Ilya Somin at the Volokh Conspiracy points out, when eminent domain reform is paired with other measures, it often fails. He gives the examples of Proposition 98 in California, which included rent control restrictions, and Proposition 90, which included "regulatory takings" provisions (these limit government ability to adopt new regulations). Understandably, those additions saw off the liberal wing of the eminent domain reform coalition. "By contrast," he says, "all twelve 'clean' anti-Kelo measures have passed, usually by lopsided margins..."  The Institute for Justice, however, does push "regulatory takings" provisions. To its credit, it did not demand them as a price for defending Initiative 31 in court.

With the passing of Initiative 31, Mississippi has given subsidy opponents leverage as well as protecting property owners from having to transfer their property to private developers, which often translates into an additional subsidy.

Tuesday, November 8, 2011

Republicans Prepare Ground to Renege on Debt Reduction Agreement

Looks like Markos Moulitsas was right, as I suspected. Ali Gharib is reporting at Think Progress Security that Congressional Republicans, including Senators John McCain and Pat Toomey, are laying the groundwork for weaseling out of the August debt ceiling accord provisions that if the Super Committee reaches no agreement, it triggers $600 billion in defense cuts over 10 years. Gharib quotes McCain yesterday (emphasis Gharib's):

The sequestration is not engraved on golden tablets. It is a notional aspiration. And those of us — and I think we’d have sufficient support to prevent those kind of cuts from being enacted because of the impact it would have on national security.

We are looking at a stand-alone bill to negate what Republicans supposedly gave up in the debt ceiling negotiations, canceling the $600 billion in defense cuts. If it passes, Democrats will have given up $600 billion in cuts to domestic programs -- for exactly nothing in return. Yet another Lucy pulls away the football moment. Gharib recommends that President Obama issue a veto threat against such a bill now, but it's not like $1.5 trillion in cuts is good policy in a jobs recession. But Gharib may be right, on the grounds that the President needs to hold Republicans to their deals. Will the President hold his ground? Get ready for the cries of "You don't support the troops."

How Transfer Pricing Hurts the Middle Class

One of the basic building blocs for understanding the effect of tax havens is the mechanism by which profits show up in the havens rather than the countries where they are really earned. This tool is known as “transfer pricing,” which at its most basic is simply the centralized setting of prices for transactions between two subsidiaries of the same company. The fact that intra-corporate sales make up much of world trade (estimates range between 33% and 60%) means that how the prices are set can have a huge economic impact.

When one subsidiary of a multinational company sells something to another one, the price for the good or service is not set in a market. A Ford transmission will not work in a Chevrolet, so there is no independent buyer for products like that. But for Ford Motor Company to know how well its various entities are doing, it has to have prices attached to intra-corporate sales. The pricing system is centralized, and can be used for multiple purposes; the most interesting for our purposes is shifting profits into lower tax jurisdictions. The charts below show how this works. In the example, it is the price of the transmission that is set via transfer pricing for the sale of French-made transmissions for use in final assembly in the U.K. All numbers are arbitrary.



Ford France


Ford UK




Price of car
15000
Price of transmission
1000
Price of transmission
1000
Cost of production
500
All other costs
12000
Pre-tax profit
500
Pre-tax profit
2000
Tax at 40%
200
Tax at 20%
400
Post-tax profit
300
Post-tax profit
1600

Total post-tax profit: $1900



Ford France


Ford UK




Price of car
15000
Price of transmission
600
Price of transmission
600
Cost of production
500
All other costs
12000
Pre-tax profit
100
Pre-tax profit
2400
Tax at 40%
40
Tax at 20%
480
Post-tax profit
60
Post-tax profit
1920

Total post-tax profit: $1980

We have the same car, the same final selling price, the same cost of production, the same pre-tax profit. But by reducing how much Ford France charged Ford UK for the transmission, profit was shifted into the lower tax country (in this example, the UK). Post-tax profit increased by the change in sales price ($400) times the difference in the tax rate (20%).

Of course, it is not like tax authorities don't know that shenanigans like this can arise. But it can be hard to detect it even if you're looking for it. Richard Caves' Multinational Enterprise and Economic Analysis provides a good overview of many research studies, which have found that it easier to get away with abusive transfer pricing when there is no real arm's length market for the good. For example, there is obviously a large market for spark plugs, so it's relatively easy to see if the price a company assigns for their sale between subsidiaries makes sense. On the other hand, there is frequently no market for a company's patents, because it often does not want to license them to other firms because they are a source of competitive advantage. That explains why Microsoft put patents in an Irish subsidiary where the royalties are untaxed: there is no good way to determine if the prices charged to other subsidiaries for their use is a reasonable one or not.

We see, then, that by a relatively simple mechanism a company can make its profits show up in lower tax jurisdictions. As previous columns discussed, most multinationals have a substantial network of subsidiaries in tax havens to reduce the taxes they pay in the U.S. and other developed countries. Their reduction, of course, means higher taxes for us, higher deficits, program cuts, or some combination of the three.

My next post will deal with how to combat tax havens.

Monday, November 7, 2011

How Profitable Fortune 500 Companies Save $70 Billion a Year in Taxes

A new report by Citizens for Tax Justice and its sister organization, the Institute for Taxation and Economic Policy (h/t Dirt Diggers Digest), documents the extent to which the Fortune 500 is able to skate around the tax system and pay far less than its fair share. The study covers 280 firms in the F500 that had pre-tax profits in the U.S. every year from 2008 to 2010, excluding companies that reported "ridiculous" geographic allocations of their pre-tax profits

Between subsidies, stock options, indefinite deferral of taxes on income earned abroad, apparently abusive transfer pricing, skillful use of tax havens, and aggressive tax shelters (which can only be identified after the fact), these companies reduced the amount of their global income that was taxable in the United States, and slashed the amount paid on their U.S. taxable income by over $70 billion per year. That is, the difference between what these companies would have paid at the 35% corporate income tax on their $1.4 trillion in U.S. profits over those three years, and what they actually paid, came to $222.7 billion.

This only scratches the surface. Note that this is only the companies' U.S. income--which has already been reduced by transfer pricing, making profits show up in low-tax foreign jurisdictions. The report singles out Google and Microsoft because "almost all or even more than all of their pretax profits were reported as foreign, even though most of their revenues and assets were in the United States." In Microsoft's case, as I report in my latest book, one of its subsidiaries in Ireland had $16 billion in patent assets but almost no employees, draining royalties from the U.S. to Ireland for booking purposes. U.S. companies do not pay taxes on their foreign earnings until they are brought back to the United States. As the CTJ/ITEP report points out, if the U.S. stopped taxing foreign earnings, as for example, Herman Cain and Rick Perry advocate, this would create even bigger incentives to declare profits overseas rather than in this country.

Considering U.S. taxes only, the report shows that 30 companies paid negative tax rates on their 2008-10  domestic income, with General Electric having negative taxes in all three years, receiving $4.7 billion in tax refunds despite $10.5 billion in U.S. pre-tax income.

As I have emphasized repeatedly, what one group does not pay in taxes means higher taxes on others, greater deficits, or budget cuts. One way or the other, those of us who do pay our taxes are harmed by those who do not. This report does a great job spotlighting the worst offenders. In posts in the near future, I will discuss how transfer pricing works, and ways to tackle tax havens.