Back in the 1990s, there was a Republican Congressman from Ohio named John Kasich who was a scourge on corporate subsidies. He even ran a "Stop Corporate Welfare Coalition" and had a joint news conference with Ralph Nader, Grover Norquist, and others to oppose it on January 29, 1997. "We've reformed welfare for those who don't have money or powerful Washington lobbyists," he said there. "Now it's time we did the same for those corporate welfare programs that aid the rich and powerful." (Newark Star-Ledger, Jan. 29, 1997, no link).
Interestingly, a guy with a similar name was elected governor of Ohio last year. But this Kasich indulges in the worst kind of subsidy abuse, offering incentives to companies to move existing facilities. Governor Kasich is offering Sears $400 million to move its headquarters, with 6100 jobs, from the Chicago suburbs to Columbus. At a time when the state is engaging in substantial budget cuts including, according to the linked story, funds for local governments and school districts, it's hard to justify $400 million subsidies that create zero net jobs for the country. Moreover, by dangling these subsidies in front of Sears, Kasich (and others like him in other states) is enabling the company to extort retention subsidies out of Illinois, just like it did in 1989 when it left the Sears Tower for Hoffman Estates.
Yet this Kasich has no shame. After poaching 500 jobs from Kentucky in September, he told Sean Hannity, "I was accused in the front page of the Cincinnati Enquirer by people in Kentucky of wanting to steal all their jobs. And guess what? They're right."
The John Kasich I remember would have seen that since the states can't help themselves (two voluntary no-raiding agreements between states have collapsed in the past), there is a need for federal action. Only the federal government can pass laws to prevent subsidies from being given for relocations, or tax them so heavily a company would have no incentive to accept such inducements. If he were still in Congress, maybe he could even be persuaded to author a bill like that.
I wonder whatever happened to that guy.
Thursday, December 15, 2011
Sunday, December 11, 2011
Cost of Tax Evasion Estimated at Over $3 Trillion Annually
The Tax Justice Network late last month published a new report that deserves much wider notice than it has received so far. Authored by Richard Murphy, it uses recent estimates by the World Bank on the size of the underground or shadow economy covering 98% of world gross domestic product to calculate the amount of tax lost as a result. The totals are simply staggering.
The report finds that over $3.1
Here are the top 10 countries in terms of gross dollars lost to tax evasion. The U.S. is number 1, by virtue of having the largest economy by far, even though it has relatively low tax rates and the second-smallest underground economy by percentage of GDP.
Country GDP ($t) Shadow Economy/GDP Tax/GDP Evasion ($b)
US 14.6 8.6% 26.9% 337.3
Brazil 2.1 39.0% 34.4% 280.1
Italy 2.1 27.0% 43.1% 238.7
Russia 1.5 43.8% 34.1% 221.0
Germany 3.3 16.0% 40.6% 215.0
France 2.6 15.0% 44.6% 171.2
Japan 5.5 11.0% 28.3% 171.1
China 5.9 12.7% 18.0% 134.4
UK 2.2 12.5% 38.9% 109.2
Spain 1.4 22.5% 33.9% 107.4
As an example of the scale of tax evasion, the study ranks countries by tax evasion relative to a country's health care expenditures. Bolivia was the worst off, with tax evasion equal to 419% of health care spending; Russia was second at 311%. Overall, 67 countries saw tax evasion exceed health care spending, and for 119 countries total, it was 50% or greater.
The consequences of tax evasion are enormous. When we consider the European debt crisis or funding stress on social programs worldwide, it is clear that these figures mean the difference between solvency and insolvency for many countries. As a result, countries need a policy response equal to the task.
The report finds that over $3.1
Here are the top 10 countries in terms of gross dollars lost to tax evasion. The U.S. is number 1, by virtue of having the largest economy by far, even though it has relatively low tax rates and the second-smallest underground economy by percentage of GDP.
Country GDP ($t) Shadow Economy/GDP Tax/GDP Evasion ($b)
US 14.6 8.6% 26.9% 337.3
Brazil 2.1 39.0% 34.4% 280.1
Italy 2.1 27.0% 43.1% 238.7
Russia 1.5 43.8% 34.1% 221.0
Germany 3.3 16.0% 40.6% 215.0
France 2.6 15.0% 44.6% 171.2
Japan 5.5 11.0% 28.3% 171.1
China 5.9 12.7% 18.0% 134.4
UK 2.2 12.5% 38.9% 109.2
Spain 1.4 22.5% 33.9% 107.4
As an example of the scale of tax evasion, the study ranks countries by tax evasion relative to a country's health care expenditures. Bolivia was the worst off, with tax evasion equal to 419% of health care spending; Russia was second at 311%. Overall, 67 countries saw tax evasion exceed health care spending, and for 119 countries total, it was 50% or greater.
The consequences of tax evasion are enormous. When we consider the European debt crisis or funding stress on social programs worldwide, it is clear that these figures mean the difference between solvency and insolvency for many countries. As a result, countries need a policy response equal to the task.
Friday, December 9, 2011
U.S. Health Care #1? Color Me Dubious, Too
Aaron Carroll has a good catch on The Hill's "Healthwatch" blog giving an uncritical eye to a recent study by a British conservative thinktank, the Legatum Institute. Its 2011 "Prosperity Index" ranks the United States #1 in the world for health. Not only that, the U.S. is far ahead of #2 Switzerland, with an index of 3.54 vs. 3.03, over 16% higher. Problem is, the U.S. scores only so-so on what both Carroll and I would consider the most important variables, healthy life expectancy (27th) and infant mortality (36th), does pretty well on some measures (tuberculosis, sanitation) and poorly on others (respiratory diseases), and only ranks #1 on one of the index components: health care spending. Since the U.S. has been seeing worsening bang for our health care spending bucks, this does not compute.
As Carroll notes, it is not clear how you weight these variables in such a way that the U.S. could possibly come out #1, and the explanation gives no real clue of the relative weights, just longer and shorter lines that are supposed to tell us the relative weights without any actual numbers. More confusing still (and I think Carroll misses this), the health variables have weight in both "income" and "well-being" regression analyses. While health spending per capita is more highly weighted than life expectancy and infant mortality on the "well-being" side, as Carroll notes, on the "income" side the reverse is true. Not that the weights, whatever they really are, make sense.
Searching the prosperity.com website for the promised detail on the methodology, I was unable to find any rationale for the choice of variables (let alone their weights) beyond the bland claim that the eight sub-indices were based "on decades of empirical and theoretical research done by established experts." That certainly clears it up. More curiously still, in response to why it uses such a complicated methodology, the FAQs answer, "The Prosperity Index is an assessment of the DRIVERS of prosperity. We do not seek to identify which countries are prosperous or not." I would have thought the latter was the whole point, given that they have already imposed a concept of "prosperity" that is 50% income and 50% "well-being." Compare this with the UN's Human Development Index, which is 1/3 income, 1/3 health, and 1/3 education.
So I'll email the folks at prosperity.com and see if I can find out the answers to these methodological questions. Meanwhile, like Aaron Carroll, color me dubious, too.
As Carroll notes, it is not clear how you weight these variables in such a way that the U.S. could possibly come out #1, and the explanation gives no real clue of the relative weights, just longer and shorter lines that are supposed to tell us the relative weights without any actual numbers. More confusing still (and I think Carroll misses this), the health variables have weight in both "income" and "well-being" regression analyses. While health spending per capita is more highly weighted than life expectancy and infant mortality on the "well-being" side, as Carroll notes, on the "income" side the reverse is true. Not that the weights, whatever they really are, make sense.
Searching the prosperity.com website for the promised detail on the methodology, I was unable to find any rationale for the choice of variables (let alone their weights) beyond the bland claim that the eight sub-indices were based "on decades of empirical and theoretical research done by established experts." That certainly clears it up. More curiously still, in response to why it uses such a complicated methodology, the FAQs answer, "The Prosperity Index is an assessment of the DRIVERS of prosperity. We do not seek to identify which countries are prosperous or not." I would have thought the latter was the whole point, given that they have already imposed a concept of "prosperity" that is 50% income and 50% "well-being." Compare this with the UN's Human Development Index, which is 1/3 income, 1/3 health, and 1/3 education.
So I'll email the folks at prosperity.com and see if I can find out the answers to these methodological questions. Meanwhile, like Aaron Carroll, color me dubious, too.
Sunday, December 4, 2011
Are Incentives Ever Good Policy?
Most of my work on investment incentives is quite critical of their use. As a result, I often get questions about whether there are any good uses of incentives, or whether states have no choice but to offer them because other states or nations are using them. The research of Tim Bartik sheds important light on this topic, in terms of identifying types of incentives that can have positive national benefits. I consider also some circumstances in which using investment subsidies can be politically justified, as well as the question of whether governments are trapped in the incentive game.
According to Bartik, two types of intervention can have positive national benefits, as opposed to benefits for the local jurisdiction.His work shows that typical "smokestack chasing" incentives, while they have a positive local benefit, have negative consequences for other states, that exceeds the benefit to the state that offers the incentive: hence, a negative net national impact. This is consistent with my work at the theoretical level that governments face a collective action problem in their use of subsidies. It also is consistent with empirical finding in international work that when other countries in your region use incentives, it decreases the amount of investment your country receives.
As I said , Bartik identifies two types of cost-effective incentives: customized training for companies on the demand side, and early childhood education programs and generalized job training programs on the supply side. Neither of these is smokestack chasing, and they make up a small portion of the incentives most states offer. For example, in North Carolina, in fiscal year 2008-9, the state's Economic Development Inventory reports that total economic development spending came to $1.2 billion. Of this, less than $11 million (1%) was spent on all types of training programs. North Carolina has a well-known early childhood education program called Smart Start, which is not considered part of the economic development budget. After a "one-time reduction" (quotes because there was another reduction the following year), the program had $194 million in FY 2008-9, about 16% of what was spent on economic development subsidies.
There is one time when I consider smokestack chasing to be politically justifiable, when it is restricted to locations that meet objective criteria of economic deprivation. This is what the European Union does, and I show in Investment Incentives and the Global Competition for Capital that EU policy has reduced what individual governments have spent on incentives, and only allowed them in the poorer regions of the EU. Some U.S. states have crafted their incentive laws to favor poorer counties, but that targeting usually is weakened over time as big companies say they'll only come if they get the maximum subsidy in a richer county. With no centralized (federal) law to enforce targeting, states have repeatedly weakened it when they do have it. This is one reason I favor federal regulation of incentives.
The bigger reason is that the states don't take the impact of their incentives on other states into account when deciding their policies. Kansas' government is not elected to care if the jobs it "creates" are merely lured across the state line from Kansas City, Missouri, let alone whether Kansas' job creation indirectly reduces jobs in other states. Therefore, the states have to be restrained by federal action to get rid of the scores of billions spent on subsidies annually.
But what should states do until then? Can states unilaterally disarm? I think the answer is probably not, although the province of Alberta in Canada has done so (oil revenues are probably the reason it can do this). But you won't get credit from me for "responsible" policy if you aren't actively working for a federal solution to the problem. And as we saw as recently as 2006 when the U.S. Supreme Court ruled on Cuno v. Daimler-Chrysler, states were actively lobbying Congress to overturn the ruling should it have followed the Appellate Court's ruling in favor of plaintiffs. In other words, states don't want to give up their economic development tools, because they still fail to appreciate how they are bound in a collective action problem that is ultimately only solvable at the federal level.
In the meantime, critics need to highlight the enormous cost in cash and lost government jobs. Local successes do occur, such as the defeat this year of the $360 million Aerotropolis subsidy in St. Louis opposed by the liberal Missouri Budget Project and the libertarian Show-Me Institute. But there is still much work to do in ending the economic war between the states.
According to Bartik, two types of intervention can have positive national benefits, as opposed to benefits for the local jurisdiction.His work shows that typical "smokestack chasing" incentives, while they have a positive local benefit, have negative consequences for other states, that exceeds the benefit to the state that offers the incentive: hence, a negative net national impact. This is consistent with my work at the theoretical level that governments face a collective action problem in their use of subsidies. It also is consistent with empirical finding in international work that when other countries in your region use incentives, it decreases the amount of investment your country receives.
As I said , Bartik identifies two types of cost-effective incentives: customized training for companies on the demand side, and early childhood education programs and generalized job training programs on the supply side. Neither of these is smokestack chasing, and they make up a small portion of the incentives most states offer. For example, in North Carolina, in fiscal year 2008-9, the state's Economic Development Inventory reports that total economic development spending came to $1.2 billion. Of this, less than $11 million (1%) was spent on all types of training programs. North Carolina has a well-known early childhood education program called Smart Start, which is not considered part of the economic development budget. After a "one-time reduction" (quotes because there was another reduction the following year), the program had $194 million in FY 2008-9, about 16% of what was spent on economic development subsidies.
There is one time when I consider smokestack chasing to be politically justifiable, when it is restricted to locations that meet objective criteria of economic deprivation. This is what the European Union does, and I show in Investment Incentives and the Global Competition for Capital that EU policy has reduced what individual governments have spent on incentives, and only allowed them in the poorer regions of the EU. Some U.S. states have crafted their incentive laws to favor poorer counties, but that targeting usually is weakened over time as big companies say they'll only come if they get the maximum subsidy in a richer county. With no centralized (federal) law to enforce targeting, states have repeatedly weakened it when they do have it. This is one reason I favor federal regulation of incentives.
The bigger reason is that the states don't take the impact of their incentives on other states into account when deciding their policies. Kansas' government is not elected to care if the jobs it "creates" are merely lured across the state line from Kansas City, Missouri, let alone whether Kansas' job creation indirectly reduces jobs in other states. Therefore, the states have to be restrained by federal action to get rid of the scores of billions spent on subsidies annually.
But what should states do until then? Can states unilaterally disarm? I think the answer is probably not, although the province of Alberta in Canada has done so (oil revenues are probably the reason it can do this). But you won't get credit from me for "responsible" policy if you aren't actively working for a federal solution to the problem. And as we saw as recently as 2006 when the U.S. Supreme Court ruled on Cuno v. Daimler-Chrysler, states were actively lobbying Congress to overturn the ruling should it have followed the Appellate Court's ruling in favor of plaintiffs. In other words, states don't want to give up their economic development tools, because they still fail to appreciate how they are bound in a collective action problem that is ultimately only solvable at the federal level.
In the meantime, critics need to highlight the enormous cost in cash and lost government jobs. Local successes do occur, such as the defeat this year of the $360 million Aerotropolis subsidy in St. Louis opposed by the liberal Missouri Budget Project and the libertarian Show-Me Institute. But there is still much work to do in ending the economic war between the states.
Friday, December 2, 2011
Update on Boeing: Union to Drop NLRB Complaint, but Will Subsidy Shoe Drop, Too?
As I reported in September, Boeing and the Machinists' union were in a big dispute about awarding the second Dreamliner assembly line to South Carolina, rather than keeping it in Washington state, where the company had received $2 billion in tax breaks (present value) for the original production line. The battle reached the National Labor Relations Board because Boeing officials made public comments suggesting their decision was prompted by labor strife in Washington -- a prima facie violation of the National Labor Relations Act, because it is illegal to retaliate against workers engaging in their legally protected right to strike.
After rumors yesterday afternoon, it was officially announced late last night that a pact had been reached (h/t Talking Points Memo): in exchange for locating production of the new Boeing 737 MAX in Renton, Washington, Boeing and the union would sign a 4-year contract extension, and the union would drop its NLRB complaint against Boeing over the South Carolina plant. The company also said it would relocate defense work from Kansas to Washington if it closes what is reported to be a money-losing Kansas plant. The contract provides for a $5000 signing bonus for Boeing workers, 2% annual increases, and potential bonuses that could reach 4% per year. Boeing workers vote on the agreement December 7.
I can't help asking: what about subsidies? Basic bargaining theory in international political economy would say that if Boeing has no choice in where it locates the 737 MAX facility because of the union contract, it should not have any bargaining leverage over Washington state. Assuming the contract is ratified next week, Boeing can no longer tell state and local governments in Washington that it could move the plant somewhere else. It would be under a contractual obligation to put them in Washington, which should put the state in the driver's seat in subsidy negotiations. As we all know, that would be a very unusual outcome here in the U.S. After all, Boeing got a package for the Dreamliner equivalent to a $2 billion cash grant, more than twice the cost of the $900 million factory (see my new paper I mentioned in my last post). Are we going to find out in a couple of weeks, or a couple of months, that the state guaranteed subsidies as part of this deal? I'd say it's very possible, but if the Boeing-Machinists' union deal really did tie down the company, there is no reason for the state to give away the store again. As President Bush so eloquently put it, "You can't get fooled again."
After rumors yesterday afternoon, it was officially announced late last night that a pact had been reached (h/t Talking Points Memo): in exchange for locating production of the new Boeing 737 MAX in Renton, Washington, Boeing and the union would sign a 4-year contract extension, and the union would drop its NLRB complaint against Boeing over the South Carolina plant. The company also said it would relocate defense work from Kansas to Washington if it closes what is reported to be a money-losing Kansas plant. The contract provides for a $5000 signing bonus for Boeing workers, 2% annual increases, and potential bonuses that could reach 4% per year. Boeing workers vote on the agreement December 7.
I can't help asking: what about subsidies? Basic bargaining theory in international political economy would say that if Boeing has no choice in where it locates the 737 MAX facility because of the union contract, it should not have any bargaining leverage over Washington state. Assuming the contract is ratified next week, Boeing can no longer tell state and local governments in Washington that it could move the plant somewhere else. It would be under a contractual obligation to put them in Washington, which should put the state in the driver's seat in subsidy negotiations. As we all know, that would be a very unusual outcome here in the U.S. After all, Boeing got a package for the Dreamliner equivalent to a $2 billion cash grant, more than twice the cost of the $900 million factory (see my new paper I mentioned in my last post). Are we going to find out in a couple of weeks, or a couple of months, that the state guaranteed subsidies as part of this deal? I'd say it's very possible, but if the Boeing-Machinists' union deal really did tie down the company, there is no reason for the state to give away the store again. As President Bush so eloquently put it, "You can't get fooled again."
Sunday, November 27, 2011
State and Local Subsidies to Business More Out of Control than Ever
I've just completed a new paper (not yet published, so I can't present it all here) showing the effectiveness of the European Union's rules to control investment incentives. Comparing U.S. bidding wars for investment with what happens under the EU's state of the art rules (see below) helps show just how much money is wasted by state and local governments here. As I have posted here before, the annual subsidies given could hire all laid-off state and local government workers. In this post, we examine incentives over $100 million as well as the top 25 incentives since 2000 in both the EU and U.S.
Since the beginning of 2010, there have been at least 20 $100 million incentive packages given in the U.S., compared to just four in the EU. This includes a $1 billion package (present value) given by the state of Michigan to Chrysler in 2010. By contrast, the largest package in the EU in this time was about $285 million. Overall, nine of the top 25 investment subsidies given since 2000 have been given in 2010 and 2011. This is twice as many as you would expect randomly (25*2/11=4.5), which suggests to me that things are more out of control than ever.
An important metric for comparing the size of incentives is what the EU calls “aid intensity,” which is the subsidy divided by the investment. This lets you compare incentives for projects of different sizes. Under the EU's current rules for large investments, which came into effect in 2002, the largest subsidy by aid intensity was 23.19%, a $161 million package that went to Ford Craiova in Romania in 2008. Of the top 25 packages in the U.S. since 2000, only three had a lower aid intensity than Ford Craiova, one was about equal, and the rest were higher, including four over 100%, with one as high as 385%, almost four times the cost of the investment! Thus, the highest aid intensity in the EU was virtually the lowest aid intensity for large projects in the U.S. And EU rules limit the highest subsidies to the poorest regions; the higher the GDP per capita, the lower the maximum allowable incentive, with the richest regions not allowed to give investment incentives at all.
What the EU originally called the Multisectoral Framework on Regional Aid to Large Investment Projects came into effect in 1998, and in 2002 the rules were tightened to sharply reduce the maximum subsidy the European Commission would allow* for investment projects over € 50 million. This can be clearly seen in a list of the top 25 incentives in the EU (you'll have to wait for the paper, or see Table 6.2 in Investment Incentives and the Global Competition for Capital as the top five have not changed since the book was published), where four of the five largest were given before the 2002 reform. Similarly, companies that received incentives under both the original rules and the reformed rules received much lower aid intensity under the new rules. For example, Advanced Micro Devices received a subsidy equal to 22.67% of its investment to locate in Dresden, Germany, in 2004 under the old rules, but only 11.9% in Dresden under the new rules in 2007, and 10.83% when its joint venture, Global Foundries, set up shop in Dresden in 2011. The rule change clearly worked to ratchet down incentives.
The European Union rules show that there is an alternative to giving large incentives to attract investment, that there is no reason to give away free factories to rich companies. But even in rich areas of the U.S., government officials do not want to give up their subsidy powers, so it will take constant political pressure to obtain what is ultimately a federal solution. The only way to make this politically feasible is through constantly reminding people of the high costs, what we have to give up to pay them, and pointing out feasible alternatives.
* Yes, you read that right. In the EU, the 27 independent Member States can only give a subsidy to a business if the European Commission authorizes them to do so.
Friday, November 18, 2011
How to Tackle the Tax Havens
As I argued in a recent post, tax havens cost the middle class worldwide hundreds of billions of dollars a year, which has to be made up via higher taxes on the middle class, higher budget deficits, or program cuts. In this post, I will discuss several ways to cut the tax havens down to size. Broadly speaking, we need to expose tax haven activities, neutralize them, and ultimately roll back banking secrecy, the key element of havens' existence.
Just as with subsidies, tax havens can only emerge as a political issue if their activities are widely known. One element of this is simply to report on them and keep them in the spotlight. Stories like "Tax Me If You Can" on Frontline exposed tax scams run out of the Caymans that were promoted by one of the world's major accounting firms, KPMG. But the reform that would illuminate the largest dollar volume of tax haven activity would be to force companies to report their accounts on a country-by-country basis rather than the consolidated accounts they now publish. As Palan, Murphy, and Chavagneux point out, consolidated accounts let companies hide their transfer pricing abuses because they do not report inter-affiliate transactions. Being forced to report sales, profits, size of workforce, taxes paid, etc., by location would immediately expose cases where tiny workforces, or none at all, generated big profits in tax havens. Moreover, Palan et al. note, because this regulation is enforced via the companies, it would not require the cooperation of the tax havens, most of which have been uncooperative in providing information despite agreements they may have signed.
Once exposure generates enough political pressure to get something done, specific reforms can be enacted. One way to neutralize corporate use of tax havens is to prevent transfer pricing. This can be done through what is variously called "combined reporting" or worldwide unitary taxation. This approach ignores the legally separate existence of each of a multinational corporation's subsidiaries and treats them as a single entity, using a formula to determine what percentage of the company's profits to tax. For example, if BP makes $25 billion in 2012 and 20% of its operations are in the U.S., under combined reporting the U.S. would tax BP on $5 billion. If 5% of BP's operations are in Louisiana, the state could tax BP on $1.25 billion of income. Determining the proper percentage is done by formula, using factors such as sales, employment, and assets. With combined reporting, it doesn't matter where a company claims it made its income, because the formula overrides such shenanigans.
It should be noted that the Organization for Economic Cooperation and Development, which began targeting tax havens in 1998, opposes combined reporting, despite its efficacy, because multinational corporations oppose it, and the OECD's model tax rules strongly reflect the preferences of the multinationals. Hence, there is something of a contradiction in the OECD position, as I argued in 2002.
However, these reforms still would not get at individual tax evasion, which by itself is estimated to cost governments worldwide $255 billion a year. This requires tackling secrecy directly. One model is the European Union's Savings Tax Directive, which requires that Member States either withhold 35% of interest income earned or provide complete information on all interest income earned in their territories. As Palan et al. recommend, this can be expanded beyond individuals to corporations and trusts (currently a loophole in the directive); it could obviously be expanded to other forms of income. Other measures have been used over the years that can also be effective. One, used by the U.S. Internal Revenue Service in relation to Caribbean tax havens like the Netherlands Antilles, is simply to step up auditing on transactions involving tax havens.
There is still a long way to go in stamping out tax havens. Nevertheless, progress is being made in the EU, and the political climate in the U.S. is far more favorable now than under President Bush. Palan et al. are optimistic that tax havens will be subject to continuing pressure as a result.
Just as with subsidies, tax havens can only emerge as a political issue if their activities are widely known. One element of this is simply to report on them and keep them in the spotlight. Stories like "Tax Me If You Can" on Frontline exposed tax scams run out of the Caymans that were promoted by one of the world's major accounting firms, KPMG. But the reform that would illuminate the largest dollar volume of tax haven activity would be to force companies to report their accounts on a country-by-country basis rather than the consolidated accounts they now publish. As Palan, Murphy, and Chavagneux point out, consolidated accounts let companies hide their transfer pricing abuses because they do not report inter-affiliate transactions. Being forced to report sales, profits, size of workforce, taxes paid, etc., by location would immediately expose cases where tiny workforces, or none at all, generated big profits in tax havens. Moreover, Palan et al. note, because this regulation is enforced via the companies, it would not require the cooperation of the tax havens, most of which have been uncooperative in providing information despite agreements they may have signed.
Once exposure generates enough political pressure to get something done, specific reforms can be enacted. One way to neutralize corporate use of tax havens is to prevent transfer pricing. This can be done through what is variously called "combined reporting" or worldwide unitary taxation. This approach ignores the legally separate existence of each of a multinational corporation's subsidiaries and treats them as a single entity, using a formula to determine what percentage of the company's profits to tax. For example, if BP makes $25 billion in 2012 and 20% of its operations are in the U.S., under combined reporting the U.S. would tax BP on $5 billion. If 5% of BP's operations are in Louisiana, the state could tax BP on $1.25 billion of income. Determining the proper percentage is done by formula, using factors such as sales, employment, and assets. With combined reporting, it doesn't matter where a company claims it made its income, because the formula overrides such shenanigans.
It should be noted that the Organization for Economic Cooperation and Development, which began targeting tax havens in 1998, opposes combined reporting, despite its efficacy, because multinational corporations oppose it, and the OECD's model tax rules strongly reflect the preferences of the multinationals. Hence, there is something of a contradiction in the OECD position, as I argued in 2002.
However, these reforms still would not get at individual tax evasion, which by itself is estimated to cost governments worldwide $255 billion a year. This requires tackling secrecy directly. One model is the European Union's Savings Tax Directive, which requires that Member States either withhold 35% of interest income earned or provide complete information on all interest income earned in their territories. As Palan et al. recommend, this can be expanded beyond individuals to corporations and trusts (currently a loophole in the directive); it could obviously be expanded to other forms of income. Other measures have been used over the years that can also be effective. One, used by the U.S. Internal Revenue Service in relation to Caribbean tax havens like the Netherlands Antilles, is simply to step up auditing on transactions involving tax havens.
There is still a long way to go in stamping out tax havens. Nevertheless, progress is being made in the EU, and the political climate in the U.S. is far more favorable now than under President Bush. Palan et al. are optimistic that tax havens will be subject to continuing pressure as a result.
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