Aggressive Tax Planning on the Rise, Says OECD

"Aggressive tax planning," which I would characterize as  exploitation of tax differences between countries that sits on the edge of legal tax avoidance and illegal tax evasion, is on the rise among corporations, according to a new report by the Organization for Economic Cooperation and Development (via Reuters and Reuters Tax Break).

The OECD report notably states that "concerns about distortions caused by double taxation also apply to double non-taxation." It points to practices such as deducting the same expense in multiple countries and generating multiple tax credits for the same tax payment as ways to make income "disappear." As Palan et al. (2010) have argued, corporations largely don't care whether their practices are deemed legal or not, If they get away with it, great; if not, well, paying fines is just a cost of doing business. Clearly on net this aggression has saved more in taxes than it costs in fines, if such behavior is actually increasing, as the OECD says.

Bear in mind, too, that whether the transactions are technically legal or illegal, their effect in reducing the corporate tax burden and passing it on to other taxpayers is the same.

Confirming what I have written here before that untold billions are at stake, the new OECD report gives examples of billion-plus settlements of such tax disputes. One involved four New Zealand banks that had to pay the government NZD 2.2 billion (i.e., an average of NZD 550 million per bank), a dozen Italian cases settling for 1.5 billion euro, and, largest of all, eleven tax credit transactions in the U.S. "evaded" (OECD's term) $3.5 billion in taxes owed to the government. The OECD did not make an estimate of the total cost of corporate tax planning, though the Tax Justice Network has estimated worldwide tax evasion to be $3.1 trillion annually.

The report recommends that countries introduce new laws and regulations to deal with abusive linked transactions, share information among governments, and initiate new disclosure requirements for firms to catch these transactions. While this is a step in the right direction, the OECD proposals are not very specific. Forcing companies to publish country-by-country instead of consolidated accounts would make clear what transfer pricing abuses they are perpetrating and make it politically more feasible to address them.

Swiss Bank Secrecy Reform

 Reprinted by permission of Mark Morris, h/t Tax Research UK.

The Travails of People with Health Insurance Are Not Trivial!

Austin Carroll at The Incidental Economist has posted what is at least the third installment of his saga to keep getting medication for a chronic condition. This is an excellent reminder that American health care does not just let down the 49.9 million uninsured, but fails those who have health insurance, too.

By way of background, it is important to note that Carroll is not just an expert on health care policy and IT, he is also a physician. He is, of course, insured by his employer, Indiana University. And it is there that this installment of his story begins:

Indiana University, in its infinite wisdom, changed the health care plans for the gazillionth time on January 1. This means that the laboratory I used to have to go to (which is NOT an IU [Indiana University - KT] lab – crazy) is no longer covered. So I needed to search for a new lab that would qualify as in-network. Of course, that meant that the standing order I had at the old lab needed to be reissued. So I had to call my doctor and wait for them to get me a new prescription for my labs. That took a few tries, because they couldn’t understand why I needed a new prescription. But, eventually, I got it.

 End of story? Hardly. His insurance had tripled in price, he had to get a new pharmacy, he had to navigate a labyrinthine website to request a new prescription from his doctor, only to find that the links were broken!

For those keeping score at home, none of the expense of working one's way through the bureaucracy of health insurance is counted as an expense when you see data on how much the United States spends on health care.

Is this an isolated story? Ask the approximately 6 million people who had to change pharmacies in January because Express Scripts and Walgreens couldn't reach agreement on reimbursement rates. My father, a military retiree on Tricare, was one of them. I was another one. I complained to the benefits people at University of Missouri-St. Louis that this would be horribly inconvenient to people like me who need to fill prescriptions in multiple parts of the country and benefit from Walgreens' nationwide reach. Of course this was in vain. Express Scripts is headquartered literally on my campus. The building next to mine is now Express Scripts Hall. The University of Missouri will never get rid of Express Scripts as its prescription benefits manager.

Having health insurance in America doesn't guarantee you access to health care (you have seen "Sicko," haven't you?), it doesn't deliver low costs, and it certainly throws up new kinds of bureaucratic roadblocks on a daily basis. As Carroll says, there is no way we have the best health care system in the world. Even Reason magazine editor-in-chief Matt Welch is convinced in practice, if not in theory (h/t to commenter Steve on Carroll's post).

Medical Costs Help Drive United States to Highest Bankruptcy Rate in OECD

As I have discussed before, medical bills are one of the leading causes of bankruptcy in the United States. In fact a 2009 study by David Himmelstein et al. in the American Journal of Medicine (abstract here, news story here) shows that there was a sharp increase in the proportion of bankruptcies with significant medical causes (defined as debts over $5,000, loss of income due to health problems, or mortgaging of the debtor's home to help meet medical expenses) between 2001 and 2007. According to their study, 46.2% of bankruptcies in 2001 were medically-related, while by 2007 the level had grown to 62.1%, even though bankruptcy laws had become more restrictive in the interim.

These figures have sometimes been disputed by other scholars, for example this article by Dranove and Millenson in a 2006 symposium in the journal Health Affairs, which argued that the definition of medically related used by Himmelstein et al. was far too broad.

If  medical bills are contributing to a higher proportion of bankruptcies in the U.S., we should expect to see this reflected in a higher overall bankruptcy rate than for countries where universal health insurance makes medical bankruptcy impossible. It turns out that this hunch is correct.

In 2006, Rigmar Osterkamp of the Ifo Institute for Economic Research in Munich, Germany, analyzed select OECD countries that had bankruptcy data extending over many years and which clearly distinguished between personal and business bankruptcies. Between 1980 and 2005, the United States opened up a steadily widening margin over #2 Canada, which itself was significantly ahead of the other OECD members studied (Australia, Germany, the Netherlands, Sweden, and the United Kingdom). According to Osterkamp, the U.S. and Canada had the two most debtor-friendly bankruptcy systems, though he noted that Germany's had become much more debtor-friendly in 1999 (leading to a sharp increase in bankruptcy filings), whereas U.S. law had become more restrictive in 2005. He saw this relative debtor-friendliness as the explanation for why Canada and the United States had higher rates of bankruptcy. However, he did not consider what differentiated the two countries.

As we can see from the chart, in 1982 the U.S. and Canada had virtually identical rates of around 1200 per million population, whereas by 2005 the United States was around 6000 per million while Canada was just a little over half that rate. (As Michelle White notes, the 2005 figure was inflated by consumers wanting to file under the more favorable law. According to the American Bankruptcy Institute, the figure plunged to 597,000 in 2006 but by 2010 had again topped 1.5 million filings.)

Without a detailed statistical analysis, I can't prove that the rise in medical bankruptcies accounts for the growing gap between U.S. and other OECD bankruptcy rates. But besides the suggestive fact that the proportion of medical bankruptcies grew in at least the latter part of the 1980-2005 period, we also know that U.S. per capita health care spending opened up a very similarly shaped gap relative to the rest of the OECD over the entire time span. And the finding that the U.S. personal bankruptcy rate is so much higher than that of other rich countries suggests that Himmelstein et al. are more likely closer to the truth in their estimation of the level of medical reasons for bankruptcy than are their critics.

Tax Expenditures Don't Make America Europe

Via Calculated Risk, Dean Baker takes David Brooks to task for his claim that "America is Europe." Brooks tells us:

The U.S. does not have a significantly smaller welfare state than the European nations. We’re just better at hiding it. The Europeans provide welfare provisions through direct government payments. We do it through the back door via tax breaks.

 These tax breaks, more technically called "tax expenditures," are indeed large (Brooks cites an estimate of $600 billion for 2007) and not transparent. But they have more problems than that. As the influential Citizens for Tax Justice report linked above points out, tax expenditures have further drawbacks:

1. They are essentially entitlements: If you qualify for the tax break, you get it. Following on this,
2. They are generally uncapped. It is possible to specify a maximum overall amount that can be taken through a tax expenditure (many states do this with various tax credit programs which are first come, first served, until the annual allocation runs out), but in most cases at the federal level an entity takes advantage of the tax provision when it files its taxes, so no capping is possible.
3. Unlike on-budget programs, tax expenditures rarely undergo annual review, though again in principle one could specify a sunset date to force periodic evaluation.
4. The benefits go mainly to corporations and the rich. This is even true of such "middle-class" tax expenditures such as the mortgage interest deduction, from which those in higher tax brackets and larger mortgage balances benefit the most.
5. Tax expenditures are not designed for efficient program management: why should we expect the IRS to run subsidy programs any more than we would have the Defense Department oversee Food Stamps?

Moreover, as Baker points out, there is a big difference between what we pay for social benefits and what we actually get. He highlights our grossly inefficient health care system and notes that " if we add in ...the deduction for employer provided health insurance.., the government in the United States commits a larger share of GDP for health care than almost anyone." Despite this, he adds, the U.S. does not match the European countries in terms of universal insurance (nor, for that matter, life expectancy).

The preference for non-transparency in the U.S. extends beyond the welfare state. As I showed in my book, Competing for Capital, in the European Union, subsidies to industry and services tend to be paid in the form of grants (on budget), whereas in the United States, tax expenditures are the overwhelming mechanism for such subsidies by state and local governments. Moreover, because tax expenditures do not show up in national accounts data (i.e., adding up to gross domestic product) while on-budget subsidies do, looking at "subsidies" as a percentage of GDP makes the U.S. look like less of a subsidizer than it is compared to Europe.

As a result, in the U.S. we have a patchwork system of expenditures and tax expenditures for social welfare and industrial development that is more costly and less effective than what we see in Europe. This system, if you can call it that, is also less transparent and contributes to U.S. inequality being virtually the worst in the OECD. Bottom line: America isn't Europe.

Iceland Solves Banking Crisis by Indicting CEOs, Forcing Mortgage Relief

Via Mark Thoma's Economist View, I came across an interesting blog on financial regulation called Trust Your Instincts. Lately, the author, "Richard," has written a set of posts comparing two models of dealing with the financial crisis, which he calls the Swedish model (used by Sweden and Iceland) and the Japanese model (used by Japan, the U.S., and the U.K.).

Here is his description of the two models:

Regular readers know that under the Japanese model losses on the excesses in the financial system are only recognized as banks generate the capital to absorb them.  This is good for banks because the model involves hiding their true condition and pursuing policies designed to boost bank earnings.  It is bad for the economy because it distorts asset prices and access to capital (for proof, look at the performance of Japan's economy).

The alternative is a Swedish model that is bad for banks and good for the economy.  It is bad for banks because they are required to recognize the losses on the excesses in the financial system today.  It is good for the economy because it avoids the distortion in asset prices and access to funding associated with hiding the losses under the Japanese model (for proof, look at the performance of Sweden's economy).

 Richard points to recent events in Iceland as another successful application of Sweden's model. There, the country's banks forgave loans equivalent to 13% of gross domestic product, according to a Bloomberg article Richard cites. The equivalent in the United States would be about $1.95 trillion of mortgage debt writedowns. Icelandic banks agreed to forgive all mortgage debt over 110% of a home's value.

Not only that, Bloomberg relates a development that would meet, I believe, with the approval of Tea Party members and Occupy protesters alike: Bankers were held personally liable for crashing the country's economy. The CEO's of the country's three largest banks are among 200 who are facing criminal charges, and a special prosecutor expects up to 90 more indictments. The contrast with the United States could not be more obvious.

While Iceland is a tiny country with a population of only 317,000 and a $13 billion GDP, Trust Your Instincts is not the only blog paying attention to it. As Paul Krugman wrote yesterday, "I think I may have been one of the first commentators with a wide audience to point out how relatively well Iceland was doing." What he didn't mention, though his commentator "iInfoliner" did, is that the credit rating agency Fitch upgraded Iceland's debt to investment grade last week. Moreover, according to the Business Week story, the country can now borrow in U.S. dollars at a mere 4.77%. Compare this to Greece at 35.98% and Portugal at 12.77%; even Spain and Italy are a little over 5% (the FT link has no rates listed for Ireland).

The moral of the story is that a different approach to dealing with the banks is necessary, both to restore the U.S. economy but to prosecute financiers who broke the law. As it stands, bankers have gotten off scot-free while the country's economic growth has been largely anemic. While the job market has shown a few flickers of life recently, the country needs millions of jobs just to get back where it was before the crash, which actually wasn't all that good a situation for the middle class to begin with.

It could be worse, I suppose. As Richard says, Japan's economy remains smaller than 15 years ago. But Ben Bernanke was rumored to have learned the lessons of the Japanese experience. Whatever happened to that guy?

Romney Tax Plan Blows Hole in Budget, Remains Short on Specifics

Mitt Romney unveiled his tax plan today, but it revealed few surprises except for surprisingly few specifics. Via Chris Hayes (@chrislhayes), conservative economist Josh Barro estimates that the Romney plan consists of $5 trillion in tax cuts over 10 years, divided as follows:

$1 trillion from cutting the corporate income tax
$3 trillion from cutting all personal income tax rates by 20% (not 20 percentage points, by the way)
$1 trillion from miscellaneous tax cuts like abolishing the alternative minimum tax (AMT)

According to the Romney plan, the corporate income tax rate would fall from 35% to 25% and the U.S. would stop taxing countries on their foreign profits. Contrary to Romney's claim, making foreign profits tax-free would not encourage their investment in the U.S., but would instead give companies an incentive to make more of their profits appear to be foreign by creative use of transfer pricing to make profits show up in tax havens instead of the U.S. Under the Romney plan, companies would then be free to bring that money back to the U.S. without facing any tax, anywhere in the world.

Among the other non-surprises in the plan, Romney would not increase the 15% tax rate on his own main source of income, capital gains. He would repeal the Affordable Care Act, even though his version of it in Massachusetts gave the state the highest level of insurance coverage in the country at 95%. He would raise the eligibility age for Social Security and end Medicare as we know it a la the Ryan Plan, two staples of conservative talking points that would negatively affect the middle class.

As Barro points out, Romney has said before that he will increase American military spending (already tops in the world by far). This makes it even more difficult for him to offset the $5 billion in tax cuts without huge cuts to programs that the middle class depends on. Thus, I think the inescapable conclusion is that of Benjy Sarlin: "Romney's Tax Plan Still a Boon to the Rich, Despite 1% Talk."